The main rule of demand is that a fall in the price of a certain product causes an increase in its sales. However, there are goods on the market to which this rule does not apply. In the modern world, due to the variety of offers, an amazing phenomenon occurs – an increase in demand, despite an increase in prices.
This is due to many reasons, one of which is the psychological peculiarity of a person – the desire to demonstrate one’s status by owning expensive things.
We will talk about what this effect is, how it manifests itself and what consequences it has for society.
What is the Veblen effect?
The Veblen effect is named after Thorstein Bunde Veblen, an American economist and sociologist who studied conspicuous consumption in the late 19th century. Herr Veblen was known as a witty critic of capitalism who condemned production for profit and had a great influence on socialist thinkers.
The economist, in his book The Theory of the Leisure Class, defined conspicuous consumption as a way to gain new status: “Veblen goods are a luxury item whose price does not obey the usual laws of supply and demand. Usually, the higher the price of a particular product, the less people will need it. However, there are exceptions for luxury items such as very expensive wines, watches or cars. Such items become more desirable as they become more expensive, and vice versa, less desirable if they suddenly fall in price” [ MBN, 2021 ].
The basis of the Veblen effect is an increase in the demand for luxury goods when their prices increase. As a rule, such purchases are deprived of a rational approach. Buyers buy goods not because of their convenience or usefulness, but guided by a high price tag. This demand is called indicative. A decrease in the price of a product, on the contrary, causes psychological discomfort in the consumer associated with a feeling of low-quality or fake work.
Ordinary goods are goods for which demand increases with income. However, the demand for luxury goods is growing much faster.
Goods (services) of poor quality are goods for which demand decreases with increasing income. An example of a low quality service is public transport, for which demand falls as people earn more. As soon as a person starts earning more, he stops using public transport and buys his own car [ CFI, 2021 ].
Products that people buy to increase their socioeconomic status, impress others, and make others think they have money, taste, class, and style are called positional goods [ MBN, 2021 ].
Thorstein Veblen also introduced the concept of the “leisure class” to refer to a group of people who are wealthy enough to be able to afford not to work and still make any kind of spending and flaunt it.
In the modern world, the stratum of the leisure class has increased significantly. Now bloggers are gaining popularity on social networks, demonstrating a chic life and at the same time doing nothing but maintaining their accounts. But few people think that in most cases this is just a picture that is deliberately shown to Internet users to attract an audience.
The Veblen effect perfectly characterizes the policy of many marketing campaigns. After studying the psychology of the consumer, manufacturers of expensive and branded goods assure potential customers that their product has unique qualities that can increase the status of the owner.
Such behavior is characteristic of a small percentage of consumers, who, nevertheless, have a high purchasing power. This knowledge is actively used by marketers and PR managers of well-known companies. It was for this segment of consumers that such concepts as “economy”, “standard”, “business”, “premium”, “luxury”, “VIP”, etc. were introduced.
Examples of Veblen products
Demand and supply set the pricing policy. If supply exceeds demand, then the prices of goods decrease. When demand increases, prices, on the contrary, rise. The Veblen paradox demonstrates the situation of an increase in demand with an increase in the price of a particular product or service [The Quarterly Journal of Economics, 1950].
It is possible to get into the group of Veblen products if the price of this product increases in an amazing way. An increase in the price of a commodity, in turn, raises the status of its owner. Often, such purchases become even more desirable, because due to the high price, the goods receive the status of exclusive [Handbook, 2021].
Veblen products include:
- designer items (shoes, clothes, accessories);
- antiques;
- works of art;
- jewelry;
- real estate;
- gems;
- collection wines;
- expensive equipment;
- cars.
According to Veblen, buyers who want to own these goods equate their often inflated price with high status. This purchase is one of the forms of demonstrative behavior caused by this effect.
Jewellery is very popular among people with high incomes. Every year, the growth in sales of expensive jewelry in Russia increases by 9-13% [ Concept, 2017 ].
During the economic crisis, the middle class suffers first of all. People with a high level of income, as a rule, do not change their habitual lifestyle and do not give up expensive purchases in order to save money. It is for this reason that during a period of economic turmoil, sales of cars of the middle and budget class are declining, while sales of business segment cars are growing.
People with a high level of income make such purchases, considering them as a profitable investment of their money. According to statistics, in the first half of 2016, 25% more business class cars were sold in Russia than in the same period last year [ Concept, 2017 ].
According to marketers, the most important obstacle to buying luxury cars is the mood of buyers, but not the economic situation.
Another equally striking example of Veblen products is the well-known Apple brand. Smartphones of this company are the best-selling phones in the world. The demand for this model in Russia has been growing since 2013, despite the low incomes of the population. iPhone sales are doubling every year. So, in 2015, 470 thousand copies were sold in Russia, and only in the first half of 2016 – 380 thousand [Concept, 2017].
Apple products are classified as Veblen products, because most often users choose them, guided by the big name of the brand and believing that the possession of this technology will increase their status in society.
The Veblen effect is also often found in pharmaceuticals, when, making a choice between two absolutely identical drugs from different manufacturers, the buyer is inclined in favor of the expensive one, believing that it will be of better quality and more effective.
Causes of the Veblen effect
In his analysis of conspicuous consumption, Thorstein Veblen noted that for some luxury goods and services, overpricing was often associated with a higher quality product. Consequently, the price increase was perceived as evidence of an increase in the quality of the goods (the use of better raw materials or the use of high-tech equipment) [ CFI, 2021 ].
So, for example, the demand for designer items grows with an increase in their price tag. Consumers see these price increases as evidence that the designer has improved production techniques or material quality.
The Veblen effect tends to affect people who need to purchase expensive items to demonstrate their income, wealth, and even superiority. Social psychologists note that such behavior is especially characteristic of the following categories:
- People who are in transition from one level of income to another, higher.
- Young boys and girls whose self-esteem often depends on their environment and income level.
- To collectors for whom the value of the purchased goods is subjective.
- Suggestible people whose behavior is often determined by the behavior of a group of people they respect.
Veblen products are often positional products. The volume of demand for a positional good depends on how it is distributed in society. They exhibit a negative positional effect, i.e. demand for them increases with a reduction in the distribution of goods. This is because the benefit to the consumer from holding it arises solely from the fact that few own it [American Economic Review, 1996].
For example, the benefit a consumer gains from owning a designer bag encrusted with diamonds may arise primarily from the fact that not everyone in society can afford to own such a thing. Thus, for this consumer, the accessory acts as a positional product.
Veblen goods are luxury or high quality goods whose prices do not follow the typical economic laws of supply and demand. In most cases, when something rises in price, the demand for it falls. The opposite happens with Veblen goods: when their prices rise, people want to own them even more, and as a result, the demand for them increases [MBN, 2021].
Consumers purchase such products mainly to enhance their status – they are a symbol of success and income. These products are in demand because they have a high price tag. Simply put, the people who buy them want to show that they have style, taste, money and belonging to the elite circles. If the price for them suddenly falls sharply, after it, most likely, demand will also fall.
Veblen products are sold because of the desire of consumers for conspicuous consumption – extravagant and ostentatious spending. Sellers of such goods thrive on people’s psychological craving for status, respect for others, or the belief that “people get what they pay for” [MBN, 2021].
Some people are interested in consuming highly visible goods and services in order to flaunt their wealth, thereby acquiring a higher social status in their own eyes. Due to the Veblen effect, wealthy people purchase luxury items even at higher prices than they are actually worth, and brands make more profits when the Veblen effect manifests itself to a large extent in society [The Quarterly Journal of Economics, 1950].
A great example of the Veblen effect is the purchase of real estate. Some types of houses buyers buy solely because of their uniqueness and exclusivity. In this case, people are not so much interested in the basic values of a house or apartment (for example, space, comfortable and ergonomic design, quality of building materials, convenient infrastructure, good neighborhood, etc.), but a high price tag, signaling a high income level of the future owner [ Kwan OL, Masaki M., 2021].
Evidence also suggests the existence of the Veblen effect in consumer behavior associated with luxury brands. For example, the French fashion brand Chanel has been raising prices for its popular handbag lines by 20-30% per year over the past few years [ Kwan O.L., Masaki M., 2021 ].
Furthermore, the factors that determine the value of works of art are different from stocks and other investments, because the ownership of works of art, especially masterpieces, is considered a consumption of luxury goods, as well as an investment by which the owners demonstrate their wealth.
The Veblen effect is widespread almost everywhere except in the Third World (due to the large percentage of the poor). Social economists note that it manifests itself differently in the countries of the former Soviet Union and the highly developed countries of Europe. Residents of European countries prefer brands with a long history and a well-deserved reputation, while for citizens of post-Soviet states, the price is the main thing when choosing.
Some studies have also noted the importance of the spatial and temporal variation of the Veblen effect. The author himself suggested that the degree of effect should differ across domains, arguing that consumer behavior that signals wealth is more evident in communities where human contact with the consumer is greater and population mobility is higher [The Quarterly Journal of Economics, 1950].
The difference between the Veblen effect and the Giffen effect
The Veblen effect is one of a group of theoretically possible anomalies of the general theory of demand in economics. Examples of other related effects are:
- The snob effect in which consumers want to use exclusive products whose price reflects quality, style, good breeding, culture, etc. They prefer a product not because of its quality, convenience or design, but only because it is different from what everyone else usually chooses.
- The effect of joining the majority (imitation) is a psychological effect in which the preference for a product increases as the number of buyers who purchase it increases.
- The Giffen effect, which shows an increase in the demand for low-quality income that the poor can afford to maintain a standard of living.
All of these effects are excellent examples of why demand is growing despite rising prices. Each of them can be explained from the standpoint of personality psychology.
So, for example, the Giffen paradox arises due to the desire of a person to close his minimum needs. The snob effect is manifested in situations where the consumer wants to have an expensive and unique product, in contrast to the Veblen effect, for which only its price is important.
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Giffen goods are another class of goods that do not obey the classical law of demand. Unlike Veblen goods, which break the law of demand after prices rise above a certain level, Giffen goods break the law of demand until prices rise above a certain level [American Economic Review, 1996].
Even though Veblen’s goods and Giffen’s goods do not follow the traditional laws of supply and demand, they are quite different: the former are luxuries, while the latter are necessities that poor people cannot live without. Giffen’s paradox explains the increase in demand for cheap essentials (bread, cereals, potatoes, kerosene), while Veblen’s paradox shows an increase in demand for exclusive and expensive goods.
Demand for Giffen’s goods also rises as prices rise. For example, in Victorian Britain, bread was the staple food of the poor. When the price of it rose, poor households could not switch to other more expensive alternatives, such as meat. As a result, they had to buy even more bread, the only food they could afford [ MBN, 2021 ].
In one case, the consumer is either striving for the highest quality, or wants to show off, and in the other case, this is the only way for the poor to survive. The Giffen paradox is aimed at maintaining human life – without these goods, he simply will not be able to satisfy his basic needs. He needs the Veblen paradox to maintain his status and well-being.
Pros and cons of the Veblen effect
The concept of the Veblen effect characterizes a situation where a person can close his need for recognition with the help of external attributes.
Perhaps, its main advantage is the satisfaction of a person’s need for recognition and demonstration of high status through the acquisition of expensive goods. However, do not forget that in many countries there is a large stratum of people whose income level does not allow them to painlessly make expensive purchases.
Such people, guided by the desire to purchase branded items, take consumer loans, getting into yet another financial bondage. Some of them are unable to repay their debt obligations to the bank, which leads to negative consequences – the emergence of new debts, loans and a deterioration in the quality of life.
Often, people driven by brand advertising are willing to give away their last bit of money. Some of them, realizing that they are not able to earn such amounts, decide on crimes (theft, financial fraud, scams, corruption).
Purchasing exclusive goods that cost a lot of money, a person may begin to feel superior to others. This sense of self-importance and being chosen is often deceptive and leads to the destruction of any human relationship.
Conclusion
Supply and demand are the two main criteria that determine market relations. Their performance may change depending on price changes. Recently, however, non-price factors have come to the fore, setting the tone for competition.
The work of Thorstein Veblen remains relevant today – in an era of globalization and overconsumption, it is important for people to remember that it is far from things that give them status and power. Excessive fixation on expensive items, especially in the absence of financial opportunities, does not lead to good consequences.
In order not to become a hostage to the Veblen effect, you should pay attention to intangible things, remembering your values. So don’t forget about them…
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