Undergraduate Economist

Perspectives of an economics student

On Veblen Effect

Posted by Alex M Thomas on March 18th, 2007

Students of Economics have come across the ‘Veblen Effect’ while learning about the exceptions to the law of demand. The law of demand that ‘other things remaining the same, the demand for goods increased when price fell and vice versa.’ Veblen said that when prices of certain goods rose, their demand also increased. The explanation behind this was that such goods had ‘snob value’ owing to which certain people would pay more as the price rose.

Thorstein Veblen referred to ‘the noble and the priestly classes, together with much of their retinue’ when he meant the leisure class, whose activities are exceptions to the law of demand.

The concepts of Consumer Surplus and Price Discrimination will aid in explaining the ‘Veblen Effect’.

On Consumer Surplus

Consumer Surplus refers to the difference between what the consumer is willing to pay and what is actually paid. For example, if a consumer goes to a shop thinking that he can spend till Rs. 20 on a Chocolate and then purchases one costing Rs. 15, then his consumer surplus can be said to be Rs. 5.

[Source: Bob Beachill]

On Price Discrimination

Selling different units of output at different prices is called price discrimination. [Varian 2003]The sellers discriminate the buyers on the basis of their consumer surpluses. Those with a larger consumer surplus will have to pay more for the same good (With conspicuous alternations made in the product) than consumers with a lower consumer surplus. The ‘conspicuous alterations’ are made so that the higher end consumers do not choose the ones meant for the lower consumer surplus individuals. Does this mean that the consumers really have an option to choose?

An example which is used commonly is that of an airlines which attaches different prices to the ‘business class’ and the ‘economy class’. There is a significant variation in prices between these classes.

Some Observations

These days, it is a common to see those with a large ‘consumer surplus’ opting for the good that is higher priced. Now a days, prices tend to indicate the quality differences too. Same products get priced differently with certain alterations made to the appearance and way of processing which is ‘conspicuous’ to the consumer. In the case of food products, this is seen commonly.

Now, what happens to this consumer surplus in the case of such ‘product differentiation’ and ‘price discrimination’? They get absorbed by the producers. Thus, the firms are able to exercise significant control over the choices of the consumers.

On Veblen effect

When commodities and services are priced more, consumers having a high consumer surplus will purchase such goods. This effect can take place either due to the ‘snob appeal’ of the good or because of the’ firms’ price discriminating strategies’. Both these factors act together to create an exception to the law of demand.

[More of Veblen might come in the forthcoming posts]

References

1) Hal R. Varian, Intermediate Microeconomics, Sixth Edition, 2003.

Update

Thanks to one of the commenter, Ashish Tyagi, i was able to get more information and in the paper titled ‘Bandwagon, Snob, and Veblen Effects in the Theory of Consumers’ Demand‘ by H. Liebenstein in 1970 1948, he differentiates between snob, bandwagon and veblen effect.

To be more specific, he proposed analysis is designed to take account of the desire of
people to wear, buy, do, consume, and behave like their fellows; the esire to join the crowd, be “one of the boys,” etc. — phenomena of mob motivations and mass psychology either in their grosser or more delicate aspects. This is the type of behaviour involved in what we shall call the “bandwagon effect.”

On the other hand, we shall also attempt to take account of the search for exclusiveness by individuals through the purchase of distinctive clothing, foods, automobiles, houses, or anything else that individuals may believe will in some way set them off from the mass of mankind — or add to their prestige, dignity, and social status.

[More on this paper in the forthcoming posts]

 Clarification

As a reader points out, price discrimination and product differentiation cannot be used interchangeably, like i did.

The former is typically associated with Bertrand competition situations (say, price competition over goods of different varieties) whereas the latter is associated with quantity competition in oligopoly (typically monopoly) over a homogeneous good.

15 Responses to “On Veblen Effect”

  1. riot Says:

    Didn’t know snob behavior had an official economics theory to describe it :)

    Price was actually a subject in class last week. Apparently in business schools it is called product differentiation. Put it that way and it doesn’t sound as bad as price discrimination :)

  2. Alex M Thomas Says:

    Riot,
    :)

    Product differentiation and price discrimination go hand in hand. And probably, as per the situation, the words can be used.

  3. Krishworld Politics » The US poor enjoys more leisure Says:

    [...] 1) On Veblen effect [...]

  4. Ashish Tyagi Says:

    Since we are talking here of ‘snob appeal’ or ‘snob behaviour’, I must mention here that H. Liebenstein in 1948 came up with an effect called ‘snob effect’.

    Snob effect is a negetive network externality in which a consumer wishes to own an exclusive or unique good. As a result, quantity demanded is higher the fewer people who own it. (Rubinfeld & Pyndick,5th ed). The equilibrim attainment process can be found in the same book at page no 129.

    Regarding the difference between the snob & veblen effect. I think the former is related more to the quantity increase & appeal created due to rare ownership while veblen effect has more to do with the snob appeal arising due to high prices. Any correction or additon to this is welcome.

  5. Alex M Thomas Says:

    Ashish,

    I did not know the work by Liebenstein. He is said to have discussed about ‘Veblen effect’ and the ‘bandwagon effect’. [Wikipedia]

    I think all these are inter related because high prices for few goods means that only a few ‘ought’ to purchase it and it is meant only for a few- a status symbol. This can also mean ‘snob value’.

    But like you mentioned, Vebeln effect has got to do with price induced snob effects, while ‘snob effect’ would arise either out of ‘less goods’ or ‘high prices’.

    Thanks for the tips. Planning to go through Liebenstein’s work. :)

  6. Ashish Tyagi Says:

    I think the entry at Wikipedia conveys less information because the Liebenstein’s article was itself named,”Bandwagon, Snob,and Veblen Effects in the Theory of Consumers’ Demand” published in ‘Quarterly Journal of Economics 62′ (Feb 1948).

    And even I thought of going through his works, esp this article but my library don’t have access to JSTOR. Can u tell me any other way to access such articles.

  7. Alex M Thomas Says:

    Ashish,

    The correction in the date has been made.

    Like many other ‘theories’, the paper reveals that the ‘effect’ Veblen talked about was documented by academics earlier than him.

  8. vidya Says:

    giffins paradox is similar??? its a exception to the law of demand too rite ?

    ppl buying goods tht cosr more jus coz the product is ‘in’ or its a status symbol.

  9. Alex M Thomas Says:

    Vidya,

    The the goods which come under the Giffen effect are the inferior goods (Not all).

    Their quantity demanded rises when price rises, as in Veblen Effect, but the nature of goods are different.

    There are however some exceptions (to downward sloping demand). For instance, as Sir R. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it. But such cases are rare; when they are met with, each must be treated on its own merits.

    [Marshall 1946] [Via Rodda 2004]

  10. Skeptic Says:

    Alex, I enjoy reading your blog — you are doing a great job. But I think you got it wrong when you said price discrimination and product differentiation can be used interchangeably. The former is typically associated with bertrand competition situations (say, price competition over goods of different varieties) whereas the latter is associated with quantity competition in oligopoly (typically monopoly) over a homogeneous good. Hope you will issue a clarification.

  11. The US poor enjoys more leisure « Krish On Politics Says:

    [...] 1) On Veblen effect [...]

  12. nikitasharma Says:

    as far as we hav been taught,product differentiation is a unique selling device used by producers of a monopolistically competitive market(different shampoos of same brand) and price discrimination is a major feature of monopoly(1st degree,2nd degree and 3rd degree).neither can these be used interchangeably and nor is any one related to a specific sort of competition (be it price competition or quantity cometition,coz logically a monopoly has none of it and a monopolistically competitve market has only price comp as its major characteristic)

  13. Isha Asthana Says:

    yes its similar… because in giffen paradox the price effect is positive,i.e,with the fall in the price of a commodity the demand will fall and vice versa……

  14. Nishesh Bhasin Says:

    I’m in 12th, and am studying about the quality price relationship and the bandwagon effect in economics. One thing which I get confused in and would like to get clarified is : What would you call the Veblen Effect, the Quality-Price relationship under which the consumer buys a higher priced commodity thinking it to be of better quality, or the Bandwagon Effect/Articles of snob appeal, under which people purchase high priced commodities (usually luxuries) as a mark of social symbol ???

    please clear this apparent confusion caused by paradoxical text in different textbooks.

  15. Alex M Thomas Says:

    Nishesh,

    Veblen effect, bandwagon effect and snob effect affect the utility/preferences of the consumer. These are considered to be external, in the sense that, these effects do not arise out of the inherent properties of the commodity under consideration.

    As Leibenstein writes, “by the bandwagon effect, we refer to the extent to which the demand for a commodity is increased due to the fact that others are also consuming the same commodity; by the snob effect we refer to the extent to which the demand for a consumers’ good is decreased owing to the fact that others are also consuming the same commodity (or that others are increasing their consumption of that commodity) and by the Veblen effect we refer to the phenomenon of conspicuous consumption; to the extent to which the demand for a consumers’ good is increased because it bears a higher rather than a lower price.”

    The snob effect is a function of the consumption of others, while Veblen effect is a function of price.

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