Veblen Effect

Veblen Effect

The Veblen effect can be described as an irregular market behavior where we find that the consumers prefer to purchase goods that are of a higher price even though there are other goods which are similar though not identical that are of a cheaper price. This effect is either caused by the belief that the higher the price the higher the quality or by consumers desire for conspicuous consumption.  Goods that have this effect in the market are known as Veblen goods. These goods are often also positional goods. Good examples of Veblen goods include luxury cars and designer bags. By decreasing their prices the consumers preference for purchasing them also reduces because they are no longer seen as goods of high status .in a  Similar manner if the prices are increased they  become of higher status and is therefore more preferable. Conspicuous consumption on the other hand is a term that describes the extravagant spending on goods and services by consumers with the aim of displaying or showing off their income and wealth. To the mind of a conspicuous consumer, by displaying or showing off they get to attain or maintain a higher social status.

 In order to show the Veblen effects in a theory of consumption. We examine a model in which an individual’s status is defined by the way people in his social perceive his wealth. This model is not fixed to consumers overpaying for goods, but also a large consumption of the goods at a lower price. We show that the Veblen effects do not occur when this model satisfies the single crossing property and occurs when it doesn’t. This is usually caused by the existence of brands; the budget brand sold at normal price and the luxury brand sold at high price. These luxury goods are usually purchased by consumers who want to show high levels of wealth. Such goods are usually not of superior qualities to the other brands that perform the same function. They are only sold at a higher price. The consumption of such conspicuous goods tends to reduce the expenditure on other items, as such conspicuous consumption costs more to families with less wealth. This overpayment does not result in equilibrium. This clearly shows that the Veblen effects are less likely to occur. In other cases where the property does not hold the effect is more likely to occur.

The model

This model consists of six sections the first three describe the choices to be made by households, social contacts and producers. The next two sections represent the sequence of decisions made and the conditions for equilibrium. The last section defines the single crossing property in our models context.

House holds

We should consider a house hold that has to allocate resources over two types of consumption goods. One is the conspicuous,   whose quantity and quality are publicly observed.  The other inconspicuous meaning consumed privately. Only the conspicuous consumption would display wealth. The house hold has resources which it allocates to consumption of both the conspicuous and the inconspicuous goods.

Social contacts

The theory of conspicuous consumption is founded on the basis that those who display their wealth are preferentially treated by their social contacts. These social contacts only interact with part of the resources which they cannot view directly, but instead form speculations based on the households observable actions. As such with this information they may treat wealthier households better.

Producers

The goods that are conspicuous can be produced by a large number of producers.  These producers are divided into two groups, one consisting of those already producing the goods and the other of those that have the potential of producing those goods. Each producer manufactures a single product with its own label so that social contacts can easily identify it. Consumers and there social contacts usually observe prices announced by all producers. Social contacts also observe brand labels, quantities and qualities; as such they are able to determine a house holds total expenditure on conspicuous products. Consumers usually by their conspicuous products from old producers since there brands are recognized. They also tend to purchase from few vendors of the product.

Timing

The sequences of decisions are made as follows. Each existing producer will announce a quality level and a price for the conspicuous goods. The producer’s potential competitors would observe this and decide whether to enter. If they choose to join they also make the announcement. The consumers will then observe these announcements and decide on what to purchase from each producer. Social contacts observe what each household has purchased and respond accordingly.

Equilibrium conditions

 The decisions made are divided into two phases.  First where producers compete by naming prices and qualities and secondly when households make their selective purchases and the response of their social contacts on this purchases. Consumers would not spend more than the minimal amount to acquire inconspicuous goods but that is not the case when it comes to conspicuous goods.

 The single-crossing property

The model described above shows that the marginal cost of consuming conspicuous goods is higher for individuals of lower wealth. This is the single crossing property.

We have to show further that in our model if the single crossing property holds then Veblen effects would not occur otherwise they would occur.

Equilibrium with the single crossing property

We have to characterize the separating equilibrium of this model when the single crossing property holds. By demonstrating that the model cannot generate Veblen effects and robustness of this findings

Analysis of Veblen effects  

We get to establish that no household would choose to pay a higher price in order to enhance its status households would differentiate themselves by the quantity of the conspicuous goods consumed rather than by the prices or qualities of the brands chosen. This shows that if the single crossing property holds, there are no Veblen effects.

Robustness

We manage to make important assumptions. First, being the competition between the producers of conspicuous goods. It is noted that Veblen effect are not defendant upon the nature of this competition. Another assumption would be that the quantity conspicuous goods are variable. Finally even if both quantity and variety are fixed Veblen effect would not occur as long as producers can vary the quality.

 Veblen effects are a very common phenomenon in the world over. They are mainly caused by conspicuous consumption by consumers. Who believe in spending lavishly so as to be attaining a higher social standing in front of their social contacts.  In a general model where an individual’s status is determined by their social contacts perspective of their wealth, Veblen effects cannot occur if the model follows the single crossing property.