Sunday 16 March 2014

Why are weddings so expensive?

This Washington Post blog post by Caitlin Dewey caught my eye, talking about a US$99 wedding dress. This lies in stark contrast to weddings in general which are terribly expensive (these ones are totally out of hand). Why?

Let's start with the simple explanation, and let's stick for the moment with wedding dresses (rather than wedding venues, catering, flowers, and other costs). If this was a story about supply and demand, the high price could be caused by high demand, or low supply. I'm not convinced there is high demand for weddings - the number of weddings is declining over time. Of course, we should consider demand in comparison to supply. There could be low supply because of barriers to entry into the wedding market, stopping potential suppliers from entering the market and driving the price down. Again, this seems unlikely unless there are wedding-dress-specific tailoring skills that are in short supply (this suggests not). You might think that wedding venues may plausibly have barriers to entry, but there are plenty of beautiful places that could become wedding venues if the price rises enough. So, the price here is not a result of a simple supply-and-demand story.

Dewey's blog post talks instead about signalling. But signalling by whom, to whom, and of what? Let's take a step back and think about the purpose of signalling.

Signalling is a solution to a problem of asymmetric information. This happens when one party (the informed party) has private information that the other party (the uninformed party) doesn't know, and (importantly) the informed party uses that information to their advantage and to the detriment of the uninformed party. The classic example that we use in ECON100 and ECON110 is the used car market. Sellers know the quality of the car, but buyers don't. Since buyers don't know whether they are being offered a good car or a lemon until after they have bought it, sellers can easily misrepresent the car as being good quality even if it is a lemon.

Crucially, asymmetric information is only a problem if it leads to market failure. In the used car market example, since buyers don't know the quality of the cars in the market, they have to assume that any car on offer is low quality. This lowers the amount that they are willing to pay for a car, and drives the good quality cars out of the market (since sellers of good quality cars can't convince buyers of the quality of their cars, and buyers aren't willing to pay enough to buy them). The market for good cars collapses (of course, the market has developed mechanisms that deal with this market failure, such as test drives, pre-purchase inspections, etc.). We call this an adverse selection problem, since those that select to remain in the market are those with the lowest quality cars (when at least some buyers want those with the highest quality cars, not the lowest quality). The description of these 'markets for lemons' was what George Akerlof won the Nobel Prize in Economics for (the original paper from 1970 is here (gated on JSTOR) or here (ungated)).

Signalling is one way that markets have adapted to deal with adverse selection problems. With signalling, the informed party finds a way to credibly reveal the private information to the uninformed party. There are two important conditions for a signal to be effective: (1) it needs to be costly; and (2) it needs to be more costly to those with lower quality attributes. These conditions are important, because if they are not fulfilled, then those with low quality could still signal themselves as having high quality. Sticking with used cars as an example, offering a warranty on the car is a good example of signalling. It is costly (since if the car breaks down, the seller must pay the cost of repair), and it is more costly to those with low quality cars (since they are more likely to break down).

As an aside, asymmetric information isn't a problem if it doesn't lead to market failure. For instance, the formula for Coke Zero is a closely guarded secret (though it almost wasn't), which Coca Cola knows but consumers don't. However, this information asymmetry doesn't lead to market failure because Coca Cola isn't using that information to the detriment of consumers (as far as we know!).

Back to weddings. Is there asymmetric information here that leads to market failure, and will signalling be effective? Dewey's blog post notes two types of signalling - couples signalling to their guests, and the wedding industry signalling to couples. Let's start with the second of those.

The wedding dress maker (or other part of the wedding industry, but let's stick with wedding dresses) knows the quality of their dresses, but the couple does not. So, in theory low quality dress makers can misrepresent themselves as high quality dress makers, and the couple wouldn't know until the big day when the dress falls apart. So, high quality dress makers need some way of distinguishing themselves from the low quality dress makers, through signalling. Does making the dress more expensive constitute an effective signal of quality? In theory price shouldn't act as a signal, because it doesn't meet both of the conditions above (and also because there are more effective signals of quality than price). Raising the price may entail some opportunity cost (through lost sales), so it may be costly. But, it is not more costly to low quality dress makers. So, in theory at least, price should not be a signal of quality. But as we know, consumers are not fully rational and it turns out that they do use price as a signal of quality (see this 1983 paper by Asher Wolinsky (gated on JSTOR) as an early example, or this more recent paper by Maarten Janssen and Santanu Roy (ungated)). So, the high cost of weddings might arise because high quality wedding dress makers (and wedding venues, caterers, florists, etc.) are trying to signal their quality by having a higher price.

Why are couples willing to pay such high prices for wedding dresses? It may be because they are signalling as well. They are trying to reveal two items of private information to their wedding guests (friends, family, etc.): (1) the quality of their relationship; and (2) their social status.

Starting with (1), guests don't know the quality of the relationship that is about to be formalised, but the couple does (hopefully!). Does this create market failure? That is, can the couple take advantage of this information asymmetry to their advantage and to the detriment of their guests? Maybe, if we consider wedding gifts. Guests would probably give less valuable gifts if they believed the marriage wouldn't last (i.e. if the marriage is low quality), than if they thought it would last a long time (i.e. high quality). So, if guests can't be sure about the quality of the marriage, then they may assume the marriage is lower quality and buy less expensive wedding gifts (or no gift at all) as a result. So, high-quality couples need to find some way of signalling their quality, and this may be through the cost of the wedding. This may be an effective signal, because it is costly (obviously), and more costly to low-quality couples since they may expect to marry more than once over their lifetime. So, lower quality couples may be less willing to spend a lot on their wedding than high quality couples.

What about (2)? This isn't an adverse selection problem at all, since there is no market that will fail. However, there is still signalling here - the couple may want to signal their social status to the community. Higher social status is linked with wealth, which means that couples with high social status are likely to be able to afford a more lavish wedding celebration than couples with lower social status. This is of course conspicuous consumption (where spending is intended as a way of maintaining or attaining social status). And, there is at least some evidence to support this (gated, here is an earlier ungated version) - even though the evidence is from India, it doesn't seem much of a stretch that there is something similar at play in a lot of weddings in the western world as well.

So, there you have it. Weddings are most likely costly because of signalling - the wedding industry signalling couples about their quality, and the couples signalling wedding guests about the quality of their relationship and/or their social status.

P.S. I have neglected the role of marriage as a signal from one partner to another. See Chapter 8 in this book for the theoretical background to this idea.

[HT: Marginal Revolution]

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