Month: March 2007

On Veblen Effect

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.

The Fellowship of Economics

The essence of Economics or Political Economy as it was called earlier (According to Adam Smith) was to provide a good livelihood for the people and also to bring in money for the state. Nowadays, economics has got lot many divisions and specialities, that I feel the essence is getting compromised.

These are some of the subjects which are closely related with economics.

Anthropology is the science that deals with the origins, physical and cultural development, biological characteristics, and social customs and beliefs of humankind.

Economic anthropology analyses decisions and behaviour of economic agents who are embedded in the networks of social relationships and cultural influences. Economic Anthropology is directly concerned with the most central anthropological issues of human nature, choice, values, and morality. [Thomas 2006]

Geography is defined as the science dealing with the areal differentiation of the earth’s surface, as shown in the character, arrangement, and interrelations over the world of such elements as climate, elevation, soil, vegetation, population, land use, industries, or states, and of the unit areas formed by the complex of these individual elements. [Dictionary.com]

Geography forms an integral part of Environmental Economics, which studies the externalities, both positive and negative, arising out of human activities.

Moreover, natural endowments have a significant correlation to the natural progress of an economy. Studies have shown that nations with abundant natural resources have grown faster.

Geographical factors can lead to poverty also. Jeffrey Sachs, in his book ‘The End of Poverty’ has given an account of this.

Demography, the study of Population draws extensively from the science of geography.

History is the branch of knowledge dealing with past occurrences. Tirthankar Roy, an Economic historian says that Economists engage with history from a desire to make the theory of economic growth more complete and intelligible. Without comprehending the history of Britain during the 1700’s one could never understand what Adam Smith tried to say. Students find Classical theories to be otiose, due to their lack of understanding of history.

Political science or politics seem to have attracted a lot of ire, but with out a proper political institution, there will be no freedom. It is a branch of social science dealing with political institutions and with the principles and conduct of government. It is therefore essential that economic policies can be framed keeping the objectives of the political institution prevailing. ‘The disjuncture between economics and politics in India’s democratic system has also been growing’ says Bimal Jalan in his book ‘The Future of India’.

Psychology is the science that deals with mental processes and behaviour. Theories like consumer preferences, irrational exuberance and specializations like behavioural economics and game theory draws heavily from psychology. Behavioural Economics is the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications. [Mullainathan and Thaler]

Sociology is the study of human social behaviour, especially the study of the origins, organization, institutions, and development of human society. Economic sociology has emerged as a separate branch in Economics; Robert Gibbons of MIT defines it as the sociology of economic actors and institutions.

Philosophy is the rational investigation of the truths and principles of being, knowledge, or conduct. J D Sethi, who specializes in Gandhian Economics, said that ‘Science of Economics is in crisis. Indeed, the main reason for the crisis is that modern economics has no philosophy whatsoever’. To understand an Economist’s theories, we ought to know the prevailing philosophy at that time. Moreover, debates were carried out to decide whether Economics was a normative science (based on values) or a positive science (based on empiric).

Thus, it becomes pertinent that the teaching of economics also touches subjects like history, psychology etc so that the student gets a more realistic picture of the event. These days, economics has become a strict discipline with various specializations and one who ventures into one specialization is unaware of the effects of variables which is outside his or her area of interest. I do not know if ‘division of labour’ is applicable in such cases as it tends to distort the real picture. Thus the need arises for a more comprehensive learning of the social sciences.

India and it’s ‘Segregated Growth’

This article tries to show that high rates of GDP in India need not trickle down to the rest of the masses and also strives to explain why ‘segregated growth’ further fuels inequality. By ‘segregated growth’, I refer to growth which takes place in sectors which employ relatively a small percentage of the total labour force.

The IT revolution is happening but the GDP contribution of agriculture is decreasing.’ One inference from this change could be that, labour from agriculture is migrating to the services sector; but that is not the case in India. India is witnessing farmer suicides, increased debts, droughts and low productivity in the agricultural sector.

Sustained economic growth requires progress in several dimensions ‘ education, health, infrastructure, legal institutions, etc. [Noll 2006] For the whole of the population to enjoy sustainable growth, it is essential that growth takes place in all sectors of the economy. Otherwise, it will lead to growth, but only in a few sectors, like the IT boom which India faced. This growth is not sustainable in the long run. Another consequence of such ‘segregated growth’ is that, the GDP figures will show an increase. And as the GDP is the most commonly used (By the media) measure among the masses to portray economic growth, the picture presented will appear rosy.

Moreover, the per capita income will also show a rise due to the increase productivity coming from ‘such sectors’. This increased GDP will not trickle down as many economists and others state. This increased income accruing to the denizens of ‘such sectors’ will only be spent in conspicuous consumption. Thorstein Veblen coined the words ‘conspicuous consumption’ in his book ‘The Theory of the Leisure Class’. The basis on which good repute in any highly organised industrial community ultimately rests is pecuniary strength; and the means of showing pecuniary strength, and so of gaining or retaining a good name are leisure and a conspicuous consumption of goods. [Veblen 1899]

On Poverty

And though the country (India) has made significant strides ‘ poverty levels are roughly 35%, down from close to 60% in the 1970s, (by the World bank’s $ 1 a day definition of poverty, though precise numbers are the subject of never-ending debate) – the benefits of this rapid growth are yet to trickle down to the masses. [Bhusnurmath 2006]

Development agencies define poverty as an income of less than $2 per person per day (about $3,000 annually for a family of four). By this standard, nearly 3 billion people are poor. [Noll 2006]

I wonder why India still defines poverty as an income of less than a dollar per day for a person. I had argued for a restructuring of the current poverty line in another article of mine. Probably the present estimate makes it easier to state that poverty levels have come down from 60% to around 35%!

On Development

Amit Bhaduri, in his recent paper in the Economic and Political Weekly, wonders if it is Developmental Terrorism or Development which is taking place.

Destruction of livelihoods and displacement of the poor in the name of industrialisation, big dams for power generation and irrigation, corporatisation of agriculture despite farmers’ suicides, and modernisation and beautification of our cities by demolishing slums are showing everyday how development can turn perverse. [Bhaduri 2007]

Conclusion

Thus, the Indian populace is dichotomized in terms of economic growth; there are certain areas where growth levels are very high along with a majority of sectors which are witnessing a decline. Thus, this kind of ‘segregated growth’ fails to ‘trickle down’ to other sectors of the economy.

References

1) Roger Noll, The Foreign Aid Paradox, SIEPR Policy Brief, October 2006.

2) Thorstein Veblen, The Theory of the Leisure Class, 1899. (Full book available here)

3) Mythili Bhusnurmath, Time for a reality check, www.forumblog.org, November 25, 2006.

4) Amit Bhaduri, Development or Developmental Terrorism’, EPW, February 17, 2007.