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.