Demand analysis of televisions owership in vietnam

In terms of durable goods on which the income elasticity of demand is positive, the demand must be higher according to the increase in the consumers' income.. In the case of TVs, which a

VIETNAM- THE NETHERLANDS PROGRAMME FOR MASTER OF ARTS IN DEVELOPMENT ECONOMICS

DEMAND ANALYSIS OF TELEVISIONS OWNERSHIP IN

VIETNAM

A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF

THE REQUIREMEN1S FOR THE DEGREE OF

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, SEPTEMBER 2003

VIETNAM- THE NETHERLANDS PROGRAMME FOR MASTER

OF ARTS IN DEVELOPMENT ECONOMICS

DEMAND ANALYSIS OF TELEVISIONS OWNERSHIP IN

VIETNAM

A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF

THE REQUIREMENTS IDR THE DEGREE OF

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

Student: LE QUOC THANH Supervisor: NGUYEN HUU LOC

HO CHI MINH CITY, SEPTEMBER2003

ACKNOWLEDGEMENT

Today, my thesis has been completed for official submission In order to complete the thesis; I have duly received many enthusiasm supports from many people I, therefore, would like to be thankful to all of them, especially the following people

Firstly, I would like to express my thanks to my supervisor, Mr Nguyen Huu Loc who has advised me a lot of valuable recommeniation to improve the thesis

Secondly, the special thanks shall be devoted to Dr Haroon Akram Lodhi, Project Leader of the Vietnam-Dutch MA programmes, for his teaching works, especially for very useful topic: Research Methodology that seems to be unique in Vietnam so far

I would like to thank all teachers and staff of the Project such as Mr Tran Vo Hung Son - Project Director, Mdm Nguyet, the Project secretary and Mdm Chi, the Project librarian

The special thanks is duly devoted to Dr Karel Jansen, Dr.Youdi Schipper, not only for the teaching works, but also for granted scholarships which is contributed by Dutch people Thank to the contribution of Dutch people, many Vietnamese students and

I have chance to access very academic ccurse in development economics

Finally, I am deeply indebted to my family members such as my parents and my wife who always encourage me during the studying

Ho Chi Minh City, September 8, 2003

Le Quoc Thanh

: General Statistical Office : Joint Venture

: Japanese International Cooperation : Linear Probability Model

: The Swedish International Development Agency : Television sets

:Vietnam Living Standards Survey :Vietnamese Dong (the currency unit ofVietnam) : Vietnam Electronics and Informatics Association : Vietnam Living Standard Survey

: Video Cassette Recorder : World Trade Organization

TABLE OF CONTENTS

Certification i

Acknowledgement ii

Abbreviation iii

Table of Contents iv

List of tables v

List of figures and appendices vi

CHA.PTER 1: INTRODUCTION !

1.1 BACKGROUND OFTHE THESIS 1

1.2 OBJECTIVE OF THE THESIS 4

1.3 SCOPES AND FOCUS OF THE THESIS .4

1.4 DATA COLLECTION AND METIIODOIDGY .4

1.5 STRUCTURE OF THE THESIS 5

CHA.PTER 2: TIIEORETICAL FRAMEWORK 6

2.1 SUPPLY- DEMAND 6

2.2 DEMAND DETERMINANTS 7

2.2.1 PRICES 7

2.2.2 INCOME 11

2.3 THEORY OF CONSUMER'S CHOICES 14

2.4 HOUSEHOlDS 23

2.5 THE QUAliTATIVE RESPOND MODEL AND DEMAND ANALYSIS 25

2.6 EMPIRICAL STUDIES 26

2 7 CHAPTER REMARKS .• 29

CHAPTER 3: AN OVERVIEW OF VIETNAM'S ELECTRONICS INDUSTRY AND TELEVISIONS 31

3.1 VIETNAM'S ELECTRONICS INDUSTRY 31

3.1.1 THE HISTORY 31

3.1.2 CURRENT SITUATION OF VIETNAM ElECTRONICS INDUSTRY 32

3.2 SUPPLY OFTV FROM DOMESTC PRODUCTION ANDIMPORTATION 34

3.2.1 TELEVISION ASSEMBlERS 34

3.2.2 DOMESTK:: SUPPLY OFTV AND IMPORTATION 36

3.2.3 VIETNAM'S DOMESTIC PRICE IN COMPARISON WITH THE WORLD PRICE 37

3.3 ELECTRONICS INDUSTRY ANDGLOBALINTEGRATION 38

3.4 POLICIES RECOMMENDATION 38

3.5 STATISTICAL DESCRIPTION OF TV OWNERSHIP IN VIETNAM 39

3.6 CHAPTERREMARKS 41

CHAPTER 4: EMPIRICAL ANALYSIS 42

4.1 MODELSPECIFICATION 42

4.1.1 MODEL SELECTION 42

4.1.2 MODEL SPECIFICATION 44

4.1.3 ANALYTICALFRAMEWORK 45

4.2 DATA DESCRIPTION 47

4.2.1 SOURCEOFDATA 47

4.2.2 DATA SAMPLING 48

4.3 DESCRIPTIVE STATISTICS 48

4.4 RESULT OF ESTIMATION 52

4.4.1 MODEL TEST 52

4.4.2 RESULTS OF REGRESSION 52

4.4.3 COMMENTS ON RESULTS 53

4.5 CHAPTERREMARKS 54

CHAPTER 5: CONCLUSION AND POLICY RECOMMENDATION 56

5.1 CONCWSION 56

5.2 POLICY RECOMMENDATION 56

APPENDICES

REFERENCES

LIST OFT ABLES

Page

Table 2.1 :Alternative market baskets 12

Table 2.2 : Summary of demand responses to a 1% increase in income 19

Table 2.3 : Estimates of income elasticity of demand in UK 20

Table 3.1 The share of each electronics product in Vietnam 33

Table 3.2 Export of electronics product in 1991-1998 33

Table 3.3 List of TV Assemblers in Vietnam 35

Table 3.4 Market Share of some biggest TV Assemblers in Vietnam by the year 2000 36

Table 3.5 Supply of TV in Vie1nam market n the year of 1990s 36

Table 3.6 Tax reduction schedule according to AFf A/CEPT 38

Table 3.7 Share of Household owning TV in Vietnam in the year 1992 and 1998 39

Table 3.8 Share of Household owning TV in Vietnam by expenditure quintile in 1998 40 Table 3.9 Share of Household owning TV in Vietnam by areas 40

Table 4.1 Description of variables 47

Table 4.2 Probability of TV ownership across household type 49

Table 4.3: Probability of TV ownership across regions 49

Table 4.4: Probability of TV ownership across Household size 50

Table 4.5: Probability of TV ownership across Educational Level of Household head 51

Table 4.6: The result ofregressions 52

LIST OF FIGURES AND APPENDICES

Page

Figure 2.1 : Supply and Demand Curve 7

Figure 2.2 : Shits in supply 8

Figure 2.3: The welfare costs of a tariff 1 0 Figure 2.4 : Shifts in Demand 11

Figure 2.5 : An indifference curve 12

Figure 2 6 : Maximizing consumer satisfaction 14

Figure 2 7 : Income ani substitution effects 15

Figure 2.8(a) and 2.8(b) Effect oflncomeChanges 17

Figure 2.9 : Engel Curve 18

Figure 2.10 : Choices of two household faced with binary choice 21

Figure 2.11 :The derivation of threshold expenditure XT(3) 22

Figure 4.1 Logit an pro bit cumulative distributions 43

Appendix 1: 58

Appendix 2: 63

CHAPTER 1

INTRODUCTION

1.1 BACKGROUND OF THE THESIS

After over a decade of shifting to the market economy, Vietnam has achieved considerable successes in the economic development, which resulted in a higher living standard for Vietnamese From 1994 to 1999, the nominal monthly income per capita has increased by 75% (GSO, 2000) By taking the average inflation rate of 6.04% during the year of 1995-1999 (Vietnam Economics Times, 1999-2000: 4), it might be concluded that there is considerble increase in real income of people after 5 years of development

Televisions (here abbreviated as TVs) as a durable goods has become important to Vietnamese living since television services have rapidly developed nationwide It allows people to be accessed to huge source of information, basic knowledge in many fields, which is very necessary to human being and their business activities By watching television, businessmen, companies and manufacturers can update domestic or international market information, which is quite important to their business Farmers, especially in remote areas can learn more about agricultural knowledge through agricultural extension programmes, animal health care or weather forecasts which make their agricultural activities become more scientific and less risky, which leads to higher profits as a result Children, adults and elderly now may have chances to enjoy appropriate entertainment programmes that make their life more enjoyable and interesting In the same manner, young parents can learn how to take care of their babies through televised children care programmes Pupils and students can learn foreign languages, understanding more about history or geography, etc, inside and outside the country Obtaining knowledge of these fields will certainly facilitate their learning process and thus increase their human capital

In the state management aspect, the Government or state management bodies can introduce new policies, legal regulation or law in quick and cheap way to people by televised law programme Companies and manufacturers can advertise their products, services to consumers and thus facilitate their sales Consumers may enjoy open chances to

a wide range of products, which considerably supports their choices In short, TV s and television is very important to people's living, state-mana~ment works and business activities as well

As a result of the increase in people's income, according to Begg D et.al (1991), the demand for most goods will be increased (Begg D et.al, 1991: 36) In terms of durable goods on which the income elasticity of demand is positive, the demand must be higher according to the increase in the consumers' income According to the rule of supply-demand, higher demand with unchanged or less supply would lead to increase in price (Begg D et.al, 1991:36) In the case of TVs, which are durable goods and cannot be completely substituted by other products, the price will be increased in response to the increase in demand This situation may prevent a part of people oflow income groups who can not afford the increased price from using TV s while it is affordable for them if the price remain unchanged or proportionally increased with the increase in their income

Without using TV s, people will lose the chance to improve their lives in of accessing information, entertainment, basic education and other interesting televised programmes Governmental bodies find it difficult to promote legal information, new policy or law for people understanding Companies and manufacturers would also find it difficult to promote their products and services to a part of consumers In case of a developing country as Vietnam where 3 7% of total population is still under poverty line according to survey of the year 1998 (World Bank, Vietnam Development Report 2000:4), using TVs will support people to access information for improving human capital, support policy makers and governmental bodies to introduce policies and related regulations efficiently All of these activities will contribute to reduce poverty in Vietnam (Enhancing Human Capital, World Bank, 2000)

In other words, by using the services of TV s, human capital can be improved or the labour supply can be higher, potentially increasing production in society as Kooreman P.(1996) quoted Becker's view "All activities in the households are productive, even sleeping or watching television" (Kooreman P et.al, 1996:28) Therefore, the policy makers should do researches to foresee the demand trend for TV s, so that they could make appropriate policies to boost production to avoid higher prices so that people of low-income group can afford to use TVs In addition, current import tariff for imported TVs, at 60% for complete TV s is too high compared with other countries due to the policy of import substitution of the Government and thus leads to social losses This study would provide a view of TV s demand for policy makers to consider new import tariff to be close

to optimal one so that the cost of import would be equal to its benefit (Begg D et.al,

1991:594) and TVs domestic makers will be more efficient due to facing with competition against overseas makers, leading to an increase in consumer surplus

For investment aspect, the increase in demand would lead to larger market for current producers having better chances for expanding production or penetration for new comers to the market In order to make investment decisions, quantitative demand analysis

of certain commodity should be carried out to evaluate the possibility of investment

Considering the context of Vietnam or other developing countries as well, where human capital should be boosted up to fight the poverty, cheaper TV s will surely support this process In other aspects such as domestic or foreign investment, the result of this research would facilitate the investors to be more confident to invest in TV s production This investment could contribute considerably to total investment that is important to the Vietnam ecooomy

1.2 OBJECfiVE OF THE THESIS

The thesis is to explore what factors have significant affects on ownership of TV in Vietnamese households and thus affecting demand of TV s in the whole market of Vietnam Based on the found results, the policies would be drawn out, targeting at cheaper TV s for better chances of household consumption

1.3 SCOPES AND FOCUS OF THE THESIS

The thesis will focus mainly on demand analysis, household income, household characteristics that affect demand of durable goods The thesis is expected to answer the following sub-questions:

1 What are the important determinants of household demand of TV s?

2 How is the current situation of Vietnam's electronic industry in which TVs as integrated part and television service of Vietnam as supplementary for using TVs?

3 What policies needed to supports Vietnamese households as consumers and producers ofTVs in Vietnam?

1.4 DATA COLLECfiON AND METHODOLOGY

As we are interested in examining and finding what factors significantly affect ownership status of TV s in the Vietnamese household, an econometric modeling approach,

specifically logit regression, will be used to deal with the research questions The model would probably consist of a single equation in which it is assumed that the ownership of

TV as the dependent variable on the left hand side of the equation It would depend on the series of independent variables such as household income, price of TV, and other characteristics of household and household members These variables will be considered as explanatoty variable( s) on the right hand side

Data extracted from VLSS will be used to feed the econometric model The data from VLSS 1997-98 will be used due to its advantages in comparison with VLSS 1992-1993 which will be described in the Chapter 4, including sampling method

In addition to running the econometric analysis of TV ownership, descriptive analysis

of TV s and electronic industry as a whole will be presented by collecting data from other sources as tertiary data Television services and electricity industry of Vietnam will be also described as supplementary factor of TV demand

1.5 STRUCTURE OF THE THESIS

The Thesis will contain 5 chapters in which the Chapter 1 is the introduction chapter Extensive background of the thesis will be presented How the TVs and Television as supplemen1ary factor affects people living, people work as the society as the whole Problem statement is focused to facilitate the rationale of the study Data and methodology

of the study are also outlined and included

Following the Chapter 1 of introduction, the Chapter 2 of theoretical framework will present the most relevant theories relating to the basic concepts such as demand and supply, income and price, and household as unit of study including interactions in household that affect household's decision-making process of consumption Theory of consumer choices will be strongly emphasized as the main theory in which household plays the role as individual consumer subject to the utility maximization rule The later part of the Chapter is for discussion of qualitative respond model, which would be considered as basic model for econometric regression To support the model building, a number of empirical studies will

be presented and finally all findings of theoretical framewmk will be summed up at the end

of the Chapter

The Chapter 3 will be used to describe an overview of Vietnam electronic industry, televisions industry and current situation of TV makers in Vietnam, mainly based on data collected from various sources such as magazines, journal, internet site, past studies Current structure of TV s market and operation situation of maker will be presented, aiming

at providing the general picture of TV, electronic industry and televisions The Chapter will also present summery of policies, which are collected from various part studies about Vietnamese electronic industry

The Chapter 4 as the key part of this Thesis will present the description of data and data sampling methods for descriptive and econometric analysis The later part of the chapter will be the results of econometric regression and final part is the Chapter remarks

The Chapter 5 will present conclusions, policy implications Limitation and further study, which would be suggested is the end of the Chapter

CHAPTER2

THEORETICAL FRAMEWORKS

We start this important chapter by surveying a series of theories in which demand and supply theory is firstly introduced in Section 2.1 as the fundamental part of this study By looking through the demand side, there will be a number of demand determinants, which would be critically analyzed in Section 2.2, such as price of goods, substitution, consumer's income, and choices, taste or preferences The important theory of consumer's choices will

be presented in Section 2.3 to provide a deeper look on another aspect of consumption: consumer's behavior

In this study, household will be considered as the unit of analysis and thus household analysis shall be deeply analyzed as rational consumers subject to budget constraints and utility maximization A number of household characteristics such as household's size, education and age of household's head which usually have significant affects on the decision

of goods consumption will be rapidly discussed in light of household demand In addition, household is generally a group of people and thus decision-making process and mechanism within household should also be analyzed with pretty careful proposition All topics related

to households and household's decision-making process are presented in Section 2.4 of the Chapter Section 2.5 will be devoted for analysis and discussion of Qualitative Respond Model, which is widely used in demand analysis In order to support for the choice of model for economic regression in the Chapter 4, a number of empirical studies will be presented and justified in light of household demand of durable goods in Section 2.6 Section 2.7 as final part of this Chapter will summarize all available findings and conclusions of this Chapter

2.1 SUPPLY- DEMAND

Supply and demand concepts are fundamental ones in demand analysis and can be applied to several economic problems by which we may see how market conditions affect the supply and demand side of any product or to examine the effect of policy on market, on price

or production As shown in the simplest diagram below, on which demand and supply mechanism will be illustrated as the vertical axis show the price level and horizontal axis show quantity demanded level corresponding to price The demand curve D intersects with supply curve at the point A that is called equilibrium point At the equilibrium point, the

market will reach equilibrium status From this point, we can derive the equilibrium price or market-clearing price and corresponding quantity demanded

Price

Pl

PO P2

be more aggressive to supply more goods

The demand curve shows the difference that how much quantity demanded by consumers at each price level Higher price will force a part of consumer to choose another goods to consume or give up consumption of goods Downward-sloping shape of demand curve telling us the higher price will depress consumer's willingness to buy Therefore, at any price higher than equilibrium price, it will cause the surplus because producers wish to supply more while consumers tend to buy less Vice versa, at any lower price than equilibrium price will cause shortage because demand of goods is higher than supply willingness of producers

2.2 DEMAND DETERMINANTS

2.2.1 Prices:

As the aim of this study is to carry out the demand analysis; we would like to concentrate on demand side and the factors affecting demand only as below part

The demand curve or quantity demanded will depend on the series of factors, here called as demand determinants such as price of goods, price of substitution or complement goods, consumer's income, consumer's taste or preference The changes in such determinants will create the shifts of or movement along the demand curve The Figure 2.2 below is devoted to illustrate the effect of changing in price of goods on quantity demanded which create the new equilibrium point

is going down, leading to cheaper price of the goods, the producers will be willing to supply

at the lower price P2 that expect more quantity demanded up to the quantity Q2 where the new supply curve intersects the demand curve D1 at the A2 as the new equilibrium point The market reaches the equilibrium status again as the result of shift of supply curve to the right from S1 to S2 • Such the circumstances were based on the basic assumption that other factors remain constant, in short by the words "other things equal' These factors would include consumer's income, price of complement goods, etc

In case, price of the goods is forced to be higher than initial one, it would be expected that the lower quantity demanded, as a part of consumer at lower income would not afford for higher price Therefore, we could conclude the price of goods is important determinant affecting demand of goods in term of quantity demanded Any changes in the price of goods

will result in changes in its quantity demanded Beside above price effect, demand of goods may also be effected by price of another goods as the following discussions

Price of complement and substitution goods:

In reality, consumers always face a lot of goods that may provide the same services

If they can not buy margarine, they may choose butter as replacement So, margarine and

butter are substitutes The demand of butter would be increased if the price of margarine is

increased (Robert S.Pindyck, et.al ,1992: 32) as consumers will choose to consume butter at relatively cheaper price than margarine In case of TV, we could not find any other goods that provide exactly the same services as TV does For example, Video Cassette Recorder (VCR) and videotape or Movie Theater might provide films However people cannot receive daily information around the world from VCR or movie theaters as fast as TVs provide So, VCR and videotape can be considered as partial substitution of TV only In general, we assume that there is no substitute goods for TV and thus substitution effect on demand of TV

is eliminated from this study

In another case, one goods must be consumed together with another such as automobile and gasoline, tram and electricity, for example In such the case, two goods are

considered as complements, (Robert S.Pindyck, et.al ,1992 : 32), for which an increase in

price of one goods will result in lower demand of another one and vice versa When people enjoy services of TV s, there are two basic complements as television broadcasting and electricity So, the change in price of electricity and television broadcasting services, if any, will certainly affect demand of TV

Price of goods in world market

In the era of economic integration as today, most of national economy tends to be more open to the regional or world economics activities Importation or exportation of goods and services are integrated part of these activities Importation of goods will affect domestic demand by their price or quality In this figure below, we illustrate the effect of world price

on domestic demand through importation, plus import tax effect

Price

Pt

Pw

D

Osl Os2 Od2 Odl

Figure 2.3: The welfare costs of a tariff (Source : Begg D et.al, 1992:593)

Quantity

The domestic market without importation is assumed to have the supply curve S and demand D, which cross each other at the point A as equilibrium point The world price of that goods is Pw, lower than the domestic price If importation is allowed under the tariff imposed at the level equal to (Pt-Pw), the quantity demanded in domestic market will be Qd2 while domestic produces could supply at the quantity of Qs2 The shortage of "Qd2-Qs2) is fed by importation In the contrast case, if domestic price is lower than world market price, exportation is expected to take place and a part of consumer will have to give up consumption of that good Above argument allow us to conclude that price of the world market will also affect demand of good in domestic market as well as other mentioned price above

It might be useful for this study to go further in term of consumer benefit, thank to open trade so that goods at lower price from the world market will flow into the domestic However, if government imposes the tax as above, consumers have to pay extra payment

Where such the extra payment will come? According to Begg D.et.al (1991) the total extra consumer payment is the area LFHG that can be divided into a number of cost and revenue as: (1) the government revenue will be increased by the area EFHI as result of the quantity of goods imported under the tax imposed; (2) Producers will receive extra profits by the area ECJL; (3) A number of inefficient producers will receive amount of extra consumer payment by ECI thank to imposing tax This amount is also considered the cost of society to

support these inefficient firms; ( 4) The area FGH represent the social losses due to reducing

in quantity of consumption from consumers Now, we may understand how would the too high tariff rate hurt consumer's benefit In case of TV in Vietnam, import tax rate of 60% for complete sets is considerably high to make TV price in domestic higher, leading to less consumption of Vietnamese consumers In addition, such the high tariff rate will remain a number of inefficient TV makers How should the Government policy for this matter will be discussed in the Chapter 5

2.2.2 Income:

The next important determinant of demand that we should analyze is the income of consumer in general or disposable income of consumer that is defined as the amount of money that consumer is allowed to spend for him or herself after tax (Begg D at.al, 1991)

We assume that the initial status of the market is as the below figure on which the initial demand curve symbolized by D and the price of good is set up at P1 and the quantity demanded is at QJ.Price

Larger quantity demanded is recorded at Q2 as result of increase in consumer's income Such effect , in general, is called income effect However, income effect can be divided into two sub-effects as the below theory of indifferent curve

Indifferent curves:

We come to further analysis of income effects on demand by the theory of indifference curve as assumption of Robert S.Pindyck et.al (1992) that a consumer in the market usually faces with many items that they could buy and they will make comparison between some combination of goods as the Table 1, so-called "market basket" They may

be able to choose the best basket that fit their preferences most

Table 2.1 : Alternative market baskets

Market basket Unit of Food per week Unit of clothing per week

(Source: Robert S.Pindyck et.al ,1991: 61)

The consumers face with several market basket such as A,B,D,E,H and G Each of market basket combines two goods: Clothing and Food to be consumed per week According

to S.Himmelweit et.al (1998), a number of basic assumptions should be satisfied such as (1) consumer's preference are complete • It means that consumer is able to evaluate and rank all market basket based on satisfaction or utility they would gain They would prefer A to B or prefer B to A or may be they consider both A and B are equal; (2) the second is that consumer's preference are transitive It means, if they prefer A to B, and prefer B to D , they will prefer A to D; and (3) consumer prefer more to less of any goods, leaving the cost out of consideration Under these basic assumptions, consumer will be able to rank any market basket by deciding whether they prefer this one to that one or they may be indifferent

between two market baskets They will certainly prefer A to G because two of goods at the point A is larger than that of the point G In addition, the pointE is preferred than A and G because it provides larger in term of number of both goods However, we could not know how consumer prefer between A, B, D and H without additional information as the

indifferent curve is lined betweenA,B and D

How would we draw such indifferent curve? Begg D.et.al (1991) developed the concept of " marginal rate of substitution" that allow us to come to the understanding of why such the indifferent curve exist : " The marginal rate of substitution of the first goods for the second goods is the quantity of the second goods the consumer must sacrifice to increase the quantity of the first goods by one unit without changing total utility'' (Begg D, et al, 1991: 78) He assumes that consumer's preference is subject to the rule of diminishing marginal rate of substitution " Consumer's tastes exhibit a diminishing marginal rate of substitution when, to hold utility constant, diminishing quantity of one goods must be sacrificed to obtain successive equal increases in the quantity of the other goods" (Begg D, et al,1991: 79) So, the indifferent curve U1 on the Figure 2.5 is thus drawn At every point on the U1, same utility is obtained for consumer who choose a markd basket on that line

Another important determinant of consumer's demand would be consumer's choices

or preferences that is varied between person to person because of their individualism Some one would prefer this one to that one while the contrast case can be observed in another one's cases However, almost of consumers will be under their limited resources of income, time,

etc and thus their consumption behavior would be subject to some specific rules which is going to be analyzed in the following part

2.3 THEORY OF CONSUMER'S CHOICES

The theory of indifferent curve set the foundation for us to move up to the important theory of consumer choices that would answer a number of questions such as " why do consumer buy , what they buy and how do they react to changes in price of goods and their income?" (Kooreman P et.al,1996:11) As the above mentioned, consumers will be able to rank the market basket according to utility they could gain Therefore, as rational consumer, they would tend to look for the market basket that gives them utility as big as possible However, all consumers, even the King of a country, have to face with the problem that they have limited budget to buy and thus they are not be able to buy as much as they wish The line MN on the diagram below represent limited budget of consumers that is assumed to allocate for two goods: clothing and food

Under the budget line MN, consumer may devote all budget for food and will get 80 units

of food and no clothing and vice versa 40 units of clothing without any unit of food However, he needs both and thus he will choose to consume at the point on the budget line

MN According to Robert S.Pindyck et.al (1992), the utility maximizing market basket should satisfy two conditions: (1) it must locate on the budget line; and (2) it would give the consumers the most preferred combination of goods The indifferent curve is drawn to solve the problem of determining the point that satisfies both conditions above

The indifferent curve U3 represents the biggest utility that consumer cannot obtain due to out of his budget line In other words, his budget is limited to reach such level of utility The indifferent curve U1 that intersects with the budget line is possible solution because it does not exceed the budget line However, this is not the best solution as consumer could gain more utility by choosing the combination inside the area between U1 and MN The U2 is the best solution, as consumer will gain maximum utility at the point A on which the indifferent curve U2 is tangent to the budget line MN At the point A, two required conditions are both satisfied and bring to consumer the possible biggest utility

The findings above is also confirmed by S.Himmelweit et.al (1998) as neoclassical theory of consumption that consumer, as rational individual, will always maximize the utility

at given budget S.Himmelweit et.al (1998:8)

Income and substitution effects

Changes in price of one goods will lead to two impacts on consumer's behavior Let's survey the diagram below on which consumers will allocate their limited budget on two commodities jam and marmalade These two goods are substitution because consumers can change to consume jam instead of marmalade if they prefer jam or the price of marmalade is increased

The budget ZS allows them to have the maximum utility at the point A When the price

of marmalade is decreased, the consumer will respond by consuming more marmalade represented by the budget line ZT instead of ZS as the beginning They will obtain now utility position at the point B instead of point A By drawing the RP line that is parallel with

ZT, we can split the effect into two ones The first impact represented by movement from the point A to A' is called substitution effect When price of marmalade is decreased, consumer will tend to consume more marmalade instead of jam because these are substitution The second impact represented by movement from the point A' to B is called income effect Due

to decrease in price of marmalade at given budget constraint, the real income of consumer will be improved and thus consume more marmalade The way to illustrate income effect more clearly be shifting the budget line from RP that parallel with ZT to the position of ZT This shift represent the situation that consumers can afford for both goods when their real income is increased

According to S.Hiinmelweit et.al (1998), total effect of price change is the combination

of two effects : income effect and substitution effect The significance is that substitution effect can happen only by the consumers substitute a part of one goods by another In income effect, consumers might either increase consumption of both of goods or only one goods The above results allow us to come to conclusion that demand for goods depend on a set

of determinants such as price of goods, taste of consumer, consumer's income and price of substitution goods One or more than one of these determinants changed would result in change in demand function of consumers

Income-consumption curves ·

For better understanding effect of change in income on demand of goods, it might be useful to employ the concept income-consumption line to be better illustration as below two diagrams

The first diagram 2.8(a) shows the unit of clothing per month on the vertical axis and horizontal axis is devoted the unit of food per month Initial consumer income is $10 at price

of food is $1 per unit and $2 per unit of clothing As rational consumer subject to utility maximization rule, consumer will come to the choice of consumption at the point A, which is tangent between their budget line and indifferent curve Ul The corresponding unit of

clothing and food obtained are 3 and 4 units respectively On the diagram 2.8(b ), the point E

is on the demand curve D 1 that can be drawn out if we keep income fixed and vary price of food

Food

When the consumer's income is increased, for example up to $20 as illustrated by the shift of budget line to the right, the new point consumer will choose is the point D and further the point D if the income increases up to $30 We imagine that if we could combine as many

as possible the change in consumer's income, a curve that line up all the utility-maximizing points will be existed and is called "income-consumption curve" The diagram 2.8(a) and 2.8(b) could present two significance as (1) parfHrt;)V1j?;·p~~~~Hbl~~- e, the demand

~ ~ •·· l -·'·"'' • r H I·: - · 'l" · ·1··(') ucM I:••, · : r· .n , 1

~~ l , ' ·~ r·~-~ ,_) :~;.:· ~ ~~ ~~- ~:;;_ ,

~j &g~~~~~

curve of goods will be shifted as effect of income on demand ; and (2) the consumption is upward sloping shape, imply that the demand curve shifts to the right, from

income-D 1 to income-D2 and then income-D3 as income increased

However, not all of goods will have increase m demand when consumer's income increased The consumption reaction or behavior of consumers on some group of goods is different Based on such the different behavior, economists could classify goods into some group , so-called inferior, normal (necessity, luxury) or durable and non-durable as the below part

Classification of goods:

In general, for almost of goods, income increased will lead to increase in demand of that goods However, there are some exceptional cases for specific goods, so-called normal and inferiors Robert S Pindyck et al (1992) developed Engel curve based on income-

consumption line as above mentioned The diagrams below illustrate the changes of demand

of normal and inferior goods when income changes take place

diagram 2.9(b ), the demand of hamburger is increased first when income increases But later

on, when further increase in consumer's income takes place, hamburger's demand is going

down So, hamburgers are considered as "inferior" goods It should be noted that hamburger was "normal goods at the beginning when income increases However, further increase in income make hamburger become inferior? How to justify such phenomenal? My argument might be like this : at each level of living standard, consumers show different behavior of consumption For example, if consumer do not have enough food for daily consumption, they would tend to buy foods first when their income increase to feed themselves Further increase

in their income when they have enough food would result in consuming other goods rather than daily foods and thus hamburger in this case will be considered as inferior

Begg D.et.al (1991) confirmed the above by the definitions" A normal good is the good for which demand increases when income rise An inferior good is a good for which demand fall when income rise" (Begg D.et.al,1991:36)

For further, Begg D al.et (1991) already developed the concept of income elasticity Based on that we could be easy to classify goods into some categories According to Begg D et.al (1991) "the income elasticity of demand for a good is the percentage change in quantity demanded divided by the corresponding percentage change in income" (Begg D et.al, 1991:70) By comparing income elasticity of demand, we could be easy to distinguish between normal, inferior or luxury goods According to Begg D et.al (1991), demand responses to income changes can be summarized as below:

Table 2.2: Summary of demand responses to a 1 % increase in income

Categories of goods Income elasticity Change in quantity

to demand demanded Normal goods: Positive Increases

- Luxury goods >1 Increases > 1%

- Necessity goods 0< between <1 Increases <1%

Inferior Negative Falls

(Source: Begg D et.al, 1991: 72)

Durable versus non-durable goods

Example

Yachts Food Bread

A durable goods is defined as the goods that provide the services for long-periods for consumers According to Robert S Pindyck et al (1992), TV can be considered as durables

because it provide television reception services for people in long time and many people would enjoy the services of TV s at the same time Vice versa, the services of non-durable would be available for short period only Food is typical example of non-durable good so that

a meal may provide enough calories for consumer's activity within few hours and then the next meal is required However, it is necessary to classify more details as whether TV is inferior, necessity or luxury goods because for each kind of goods, consumers will have different behavior in consuming and thus their demand would be differently affected case by case

For more details, an empirical study in UK (Begg D et.al, 1991:73), categorization of goods according to income elasticity of demand is as the Table 2.3

Table 2.3 : Estimates of income elasticity of demand in UK

Broad categories of goods Income elasticity of demand

(Source: Begg D et.al, 1991: 73)

The Table 2.3 tells us that durable would have income elasticity of 1.47, larger than 1

In combination with the Table 1, it might be concluded that durable should be considered as luxury goods so that its demand will increase more than 1 percent when consumer's income

is increased by percent Taking the conclusion of RobertS Pindyck et a1 (1992:33) in which

TV is considered as durable, it is expected that demand of TV s will increase more than 1 percent when income of consumer increased by 1 percent

Demand for durable goods:

Before going into demand analysis of durable goods, it is necessary to have a look on distinction of Continuous and Discrete Choices Owning or not owning a TV can be analyzed based on qualitative choices model due to limited number of alternatives, which would

happen For TV, a household can chooses to own 0 or 1 TV, and chooses how many hours to watch that set of TV The consumer choices can be classified as continuous and discrete Choosing how many hours to watch a TV is continuous sets of alternatives and thus qualitative model seem not suitable to be applied People can not choose to buy a half of TV

or 1.2 or 1.3 of TV They have to choose 0 set; it means not buy a TV or 1 or 2 sets of TV Such the choices is called as discrete choices and qualitative model can be used

In case TV as durable, it is useful to survey demand of durable that was modeled by Deaton A, et.al (1980) A number of special features of demand for durable was emphasized

as the below are relevant to this study: (1) income considered as one of important determinant for purchasing durable; (2) the choice of whether or not to buy a durable is discrete, not continuous range as in case of non-durable The fifure 2.10 below illustrate the case of two households facing with choices of car as durable goods

(Source : Deaton A et.al, 1980:367)

q

The below theory will provide us larger view of consumer's choice in case of discrete choice in which the consumers decide to own a car or not as modeled by Deaton A et.al (1980)

pq +v*S =x

Where:

p : the price , q : the quantity of non-durable

S : taking the form of dummy, equal to 1 if owing a car or 0 in vice versus

v* : annual rental of car in case not owning a car

x: total expenditure

And the single-period utility : u = v( q, S, 3)

Where : 3 is the parameter depending on the taste or characteristics of each consumer, in this case is the household In the figure below, I1I1 and I0I0 are two indifferent curves of two household

There are two utility functions that reflect household utility level:

Uo = v (x/p, 0, 3 ) and UI = v ((x-v*)/p, 0, 3 )

By comparing U0 and U I we could conclude which household will own or not own a car Owning a car if U I > U0 and vice versa When the expenditure of non-durable is reduced from (x/p) to ((x-v*)/p), the disutility of less consuming of non-durable will be offset by the benefit of owning the durable This also reflects the situation that when the expenditure x of

a household reaches the specific level, so-called threshold expenditure XT(3) as the figure 2.11, the ownership status of durable will take place Otherwise at the lower level of expenditure or lower income level , non-ownership of durable will still exist (Deaton A et.al, 1999:367-68) It is confirmed that expenditure or income level is important determinant

Figure 2.11: The derivation of threshold expenditure xT(3)

(Source : Deaton A et.al, 1980:368)

X

In conclusion for this part of theory survey, a number of durable ownership 's determinants is confirmed including income , price of durable and consumer's characteristics When households is consumer, it will be more complicated as household characteristics is combined individual's characteristics instead of single one Further more, due to many people taking part in consumption of one goods, the decision-making process for consumption in household will also become complicated, different from the case of individaul and thus it must be carefully discussed to see any difference with individual ones Thus, the next part is devoted for analysis of household as unit of this study

2.4 HOUSEHOLDS

Crossing cultures worldwide, the household type can be classified as nuclear household type in the Western where only one or two generations living together such as parent and children and grandparent In the East or Africa, the extended household type that combine more blood-relatives or adoptive is popular More people in the household would give more different taste or preference within household and thus its effects on deciding of consumption of goods and services would be much more complicated than in the case of individual as consumer In this study, the household ownership of TV s is intended to survey and thus the consumer is the household, or in other words, we can say, household is the unit

of analysis

There are a number of definitions ofhouseholds focusing on different aspects: (1) the activities take place within households (cited in S.Himmelweit et.al, 1998) or (2) the importance role of household in society (cited in S.Himmelweit, et.al, 1998) For the purpose

of research, we may refer to use the definition presented by S.Himmelweit et.al (1998: 149)

is that " A households is a unit consisting of people with common budget who organize some aspects of work and consumption together" Interactions between household members are thus available in deciding what to do or what to be consumed In other words, each household's member would influence decision of whole family So, it is necessary to examine the mechanism in which decision making process of consuming goods and service

is took place Whether the household member could come to same solution for making and under which conditions it would take place are the useful questions that should

decision-be surveyed as the followings

The neoclassical approach of household's decision-making is presented in New Household Economics developed by Becker (1965) in which household is also considered as

"small factory" or production unit of society They have to discuss about how the household

decides what to do or to spend their time So, household is assumed as single decision making unit , aiming at maximization of joint household utility function (S.Himmelwei~

et.al, 1998:179) It is assumed that household has the common preference in some specific decisions In addition, income is shared between households' members, the people who usually taking the job to buying daily products for household would not buy for herself or buy with her own income She must act as representative for whole household in deciding to buy products and services that would be mostly accepted and enjoyed by almost family members In case of allocating household's time for earned activity (market time) and for leisure (home time), for example, the household will have choice to maximize household utility at the point where budget constraint line is tangent with indifferent curve (S.Himmelwei~ et.al, 1998:152) However, this· theory seem to be contrast with individualism in which individual usually have their own preference in consumption of goods and it is not easy to compromise among a number of people

Paul Samuelson, a Nobel Prize, presented another model of decision-making process

in household He argued that due to blood relationship, ''blood is thicker than water", available among individuals in household, each of them will keep it in mind and thus their own decision would be set in consideration of other benefit (S.Himmelweit et.al, 1998: 186)

So, family members have difference preferences orderings, however, they can come to a single collective preference for their whole family Different from other groups of people, they more easily compromise to reach a consensus for consumption in the view that maximization of whole family's welfare Basically, this theory is criticized by Becker that Samuelsion's model heavily relies on the assumption that the family members are easily to reach the same preference that is contrast with theory of individualism

Becker's analysis was relying on the role of household head In a utility maximizing household, all member action is determined by household head's preference In certain case, household head would decide for whole family How could him conclude like that is based

on the argument as although every people have their own preference, however they act in consideration of the others' happiness, especially for his/her own family members who they

have blood relationship This argument is supported by Adam Smith (1759) that every man realizes his own pleasure or pain is more than the other and the nearest people could share such feeling are his or her family members In other words, man people's utility will include not only his own consumption but also other members in the family (S.Himmelweit et.al, 1998:187) A typical example is the case ofhousehold with two members ,husband and wife, which both play the role as decision makers in their family Both of them is altruistic so that they will compromise to reach the same decision of consumption that is resulted in maximizing their utility and increasing household welfare (S.Himmelweit et.al, 1998: 187)

From both Samuelson and Becker's models, we could conclude that the household in the market could come to the consensus of deciding what to consumed be household and thus household should be considered as a consumer, having a common budget, acting as rational individual subject to the rule of utility maximization with the budget constraint

Beside household income, other household 's characteristics such as household size, educational level ages of members will also affect the expenditure patterns or income and thus affect the demand for durable goods (Deaton A et.al, 1999:191 and 367) Affect of each characteristic on demand will be detailed later in the chapter 4 to support for model specification of econometric analysis

2.5 THE QUALITATIVE RESPOND MODEL AND DEMAND ANALYSIS

According to Train K (1993) recently aggregate model is shift to disaggregate ones of individual decision-making unit due to many reasons (1) behaviors analysis is developed at individual level In addition, microeconomic development allows people to look at individual actions and thus many hypotheses of these action are established (2) recent survey data become more detailed as enough to estimate disaggregate model that would examine individual level

Some research revealed that regression results of behaviors of individual making process is not continuous, but discrete Thus, qualitative choices analysis is developed allowing suitable treatmert in some particular situation in which discrete choice existed

In any case of deciding to consume something, consumer have to choose among some items or should choose a set of many alternatives that meet the criteria (1) number of

alternative in set is finite (2) alternative are mutually exclusive (3) the sets of alternative is exhaustive

However, in some case, it is difficult to make distinction between continuous and discrete variable as example that people might decide to consume the beef at 1.1 kg per day

or 1.11 kg/per day, etc The number of weight is naturally continuous and thus it is finite For convenient purpose, this number might be round off and thus discrete variable can be existed

So, in case of household choice of durable, they can choose to own zero or one or two, three etc, but not finite number of TV Then the qualitative choice analysis can be applied for small numbers of alternatives such as the case of owning or not a TVs In this case, there are only two alternatives i.e, owing or not owning

According to Amemiya, ( 1981) there are several specific types of qualitative models, which can be classified as:

Linear Probability Model (LP):

The Van den Broecke car ownership

According to Van den Broecke ( 1987), this model was used to predict car ownership number until 2010 The model also consider saturation level of driving license owning in

population group who have the same a~, gender, education level, married or not, employed

or unemployed status and income spent are determining factors This model is suitable to predict car ownership in future as total number It does not include other factors that also have significant affect on owning or not owning a car such as car type or vintage, car cost

The joint car ownership and model of De Jong

This model was developed in Ph.D thesis of DeJong (DeJong 1989a) in University of Amsterdam, supervised by Professor Cramer, using data of Dutch Budget Survey The

model explained two points (1) whether the household decide to own or not own a car (2) The kilometer driven by that car per year Due to combination of both continuous (kilometer) and discrete alternative (own or not own), joint discrete-continuous model was em_rioyed Explanatory variable of this model are household income, household size, age, occupation, gender of household head

Hanly M and J Dargay (2000) car ownership in Great Britain A panel data analysis

The data using in this model is extracted based on the British household panel survey

in four year from 1993-1996 Ordered probit model was employed for econometric analysis

in which dependent variable is the number of car owned by household in each year that take the value of 0 , 1 or 2 or more Main explanatory variables contain household income and household characteristic such as number of adult in driving age, number of children, and number of household age in pension age or not Location dummy variables were also took into account as urbanization and population density

Train K model1993

A valuable empirical study is the model of Kenneth Train (1993), which applies to auto ownership This model illustrates households' choices that depend on characteristics each class and vintage of car as well as the characteristics of households such as number of workers in household, place of residence (Train,1993, p.134) The model is denoted generally as the below :

VncnmCn = f(Y,PncnmCn, XllCnffiCn)

(K Train, 1993 ,p.13 7)

Where:

Vnenmen: conditional indirect utility of household that own n vehicles of class en and model

men

Y : household income

n : number of cars owning by a household ( n = 0, 1,2 )

Pnenmcn : the set of length of which elements are the cost per mile of traveling by vehicles

of class en arrl model men

xnenmen: a set of both observed and unobserved characteristics affecting household's utility

The model is designed to evaluate the probability of owning no car, or one car or two cars in one household The general outcomes tell us that there is positive relationship between the household income and the number of cars owned by that household If the household income has increased that make the larger probability of that household to own a car from none or two cars from one However, this model is not so close to this study due to the reason that (1) It examines ownership of number of durable (car) in family The ownership status will take the number of 0, 1, 2, or may be 3 while our study such ownership

is requested to have only two value 0 and 1; (2) It takes the condition of durable (vintage) into consideration while such data of condition is not available in VLSS

Y = f(LSIZE, BUSCAR, URBA, ImAGE, LINC)

Where:

Y : Probability of owning private car , having the form of dummy variable with the value of

1 if owning a car or zero for otherwise

Logit model was used by researcher containing of log of household size (LSIZE), dummy variable of business car (BUSCAR) and measurable degree of urbanization on six-