The Veblen effect

March 23, 2020 8:05 AM

There is also a 'Counter-Veblen Effect', where people believe they will be admired for buying bargains or for being prudent in their purchases.

Veblen wanted to site the relationship between the economy, society, and culture.Veblen wanted to site the relationship between the economy, society, and culture.

By Vidya Hattangadi

The Veblen effect is named after American economist Thorstein Veblen, who wrote about conspicuous (which means visible) consumption; it means spending of money on luxury goods and services to display financial power. In the 19th century, the term conspicuous consumption introduced by Veblen in his book “The theory of leisure class: An economic study in the evolution of institutions.” Conspicuous consumptions occur by men, women, and families of the upper class who show off their great wealth as a means to manifest their social power and prestige either real or seeming. Veblen wanted to site the relationship between the economy, society, and culture.

Conspicuousness was in existence since ages. In 75 BCE, a band of Cilician pirates in the Aegean Sea captured Julius Caesar; the capture was a minor inconvenience for Caesar, but he took the chance to prove his worthiness. From the start, Caesar refused to behave like a captive. When the pirates told him that they had set his ransom at the sum of 20 talents (approx 620 kg of silver), he mocked at them for not knowing whom they had captured and suggested that 50 talents (1550 kg of silver) would be a more appropriate amount. He then sent his followers out to gather the money and settled in for a period of captivity. The pirates were dumbfounded. A hostage rarely negotiates his ransom. The task took 38 days. Once he was freed, Caesar managed to quickly raise a small fleet which he took back to the island where he had been held captive. He captured and killed them and took back his 50 talents of silver, along with all their possessions. Thus, in 75 BCE Caser created a Veblen effect.

Perhaps the most powerful psychological flaw exists among investors is the bandwagon effect, where people alter their behaviour to fit in with the crowd. This can lead to groupthink, where the market effectively becomes one person rather than a group of individuals. Brands such as Carter, Rolls-Royce, Aston Martin, Harrods, Champagne, Christian Dior and Louis Vuitton, etc., are perceived to be worth more, simply because they cost more. They are not any better than their counterparts. Their price alone makes them desirable. The most obvious paradox concerns function. Luxury goods are not purchased to satisfy so-called primary needs such as clothing, hunger, thirst, shelter or transport. Their function is psychological-they promote a sense of being financially powerful, and they serve as markers of a real or projected status in society.

The function of luxury goods is largely a derivative of their price. The retail price at which most luxury goods are sold can contradict classic economic theory as demand, instead of increasing with a decrease in price, follows the opposite curve. A bottle of perfume that costs 85 euros can be more attractive to a purchaser than a bottle costing 20 euros, although intrinsic differences might be insignificant. But the demand curve does not increase indefinitely with the price. Once a certain threshold has been reached, demand will drop or fall away completely. But the propensity to purchase goods and services on account of the higher rather than lower price differential compared to average prices in a generic category is undoubtedly one of the principal characteristics of the luxury domain.

As a society, we are so obsessed with how the rich live their conspicuous lives. I think it has more to do with psychology than sociology. When we think about ourselves, we swiftly fall back on class stereotypes: HIG (High Income Group), MIG (Middle Income Group) and LIG (Low Income Group). To the conspicuous consumer, a public display of wealth and power is a means either of attaining or of maintaining a given social status. Flashy people in society use such behaviour to maintain or gain higher social status. Flashiness as behaviour is deeply entrenched in the culture of our society. It is imperative to recognise how conspicuous consumption directs our spending habits and our consumption pattern.

There is also a ‘Counter-Veblen Effect’, where people believe they will be admired for buying bargains or for being prudent in their purchases. This can be seen where people boast about how little they paid for a typically expensive item. It can also be a motivator for buying in sales and low-cost outlets. A lot of research has been conducted to study cases of goods which show interface effects, and in which people seem to receive more pleasure from more expensive goods.

Perception of quality: In Veblen’s analysis of conspicuous consumption, the economist noted that for certain luxury goods and services, a higher price was often associated with the perception of higher quality. Therefore, a price increase was seen as evidence of the producer improving quality.

Positional goods: The quantity demanded of a positional good depends on how the good is distributed in society. Veblen goods often exhibit a negative positional effect, ie, the quantity demanded of Veblen good increases with a reduction in the distribution of the good. It occurs because the utility gained by a consumer from holding such a good arises purely from the fact that few other consumers hold it.

High levels of conspicuous consumption are seen as socially undesirable. High levels of conspicuous consumption may be an indicator of high levels of income inequality. And, secondly, utility provided by the goods is alleged high quality, which may not be true.

The writer is Management thinker and blogger

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