Pricing like Ferrari

This week my ECONS101 class is covering pricing strategy. Essentially, this topic is about a lot of situations (supported by real-world examples) where firms may choose not to price at the single profit-maximising price. Most of the time, deviations from the profit-maximising price involve the firm pricing at a lower price than the profit-maximising price. The firm might set a lower price in order to generate goodwill and a long-term relationship with consumers, or to sell a greater quantity so that it can take advantage of moving down the learning curve (and achieving lower costs quicker), or to keep competitors out of the market (what economists refer to as limit pricing). The thing about all of those situations is that, by setting a lower price now, the firm earns more profits in the long run. It seems to me to be less clear that firms would want to set a higher price than the profit-maximising price now. Unless they face consumers like this:

Perhaps some consumers are simply willing to buy a good because it has a higher price. That is the basis of conspicuous consumption (which I have written about before here). However, I want to take this in a different direction, because firms can set a high price without needing to rely on conspicuous consumption, even when it seems like a possible explanation for what the firm is doing. Consider this example from the Wall Street Journal last month (ungated version here):

With a list price of $3.7 million, Ferrari’s new “hypercar” was revealed to the public in October with a twist: It wasn’t available for sale.

All 799 units of the low-slung, high-haunched F80 model—the most expensive production vehicle in Ferrari’s history—had been promised to top customers like Luc Poirier.

The Montreal real estate entrepreneur already owns 42 Ferraris. He said he felt “lucky” to be allowed to buy yet another.

“To be chosen by Ferrari for one of their hypercars is a true milestone for any collector,” he said.

Money isn’t enough to buy a top-of-the-range Ferrari. You need to be in a long-term relationship with the company.

By leveraging the rabid fandom of its customers through a business model based on uber-scarcity, the storied Italian company is enjoying a new golden age.

When goods are scarcer, the marginal consumer is willing to pay more for them. This is the 'Law of Demand' working in reverse. If the firm restricts the quantity it sells, then it moves up the demand curve and can sell at a higher price. However, by definition, setting a higher price than the profit-maximising price decreases profits. And, there doesn't seem to be a mechanism where over-pricing their cars gives Ferrari a long-term increase in profits. So, let's consider what they are actually doing.

Consider the market for regular, run-of-the-mill Ferraris. Because there are lots of substitutes for a regular, run-of-the-mill Ferrari, the demand for Ferraris is relatively elastic (shown by the flat demand curve D1). When Ferrari prices its cars, it sets the price so that it will sell the quantity where marginal revenue is exactly equal to marginal cost. That is the quantity Q*, and the price P1. The mark-up for Ferrari is the difference between P1 and marginal cost (MC). 

Ferrari could try setting the price higher than P1, but as noted above, this would decrease the quantity sold below the profit-maximising quantity Q*, and by definition this would decrease Ferrari's profits. So, how could Ferrari increase its profits from selling run-of-the-mill Ferraris? One way is to make demand less elastic (making the demand curve steeper). If the demand curve was steeper, like D0, then the profit maximising price would be P0 rather than P1, and the mark-up on run-of-the-mill Ferraris would be much higher. Selling run-of-the-mill Ferraris would be much more profitable.

If you are a seller, how can a firm make demand for its good less elastic? One of the factors that affects the price elasticity of demand is the number of close substitutes. If the firm can decrease the number of substitutes, or make its good less substitutable by other goods (reducing the number of close substitutes), then demand will be less elastic.

This is what Ferrari is doing by selling its most premium cars only to consumers "in a long-term relationship with the company". If you really want a Ferrari hypercar (or whatever the latest release Ferrari is), then you need to be buying run-of-the-mill Ferraris. That makes other luxury cars less close substitutes for a run-of-the-mill Ferrari, making demand for run-of-the-mill Ferraris less elastic, and allowing Ferrari to set a higher price for run-of-the-mill Ferraris. Since Ferrari sells a lot more run-of-the-mill Ferraris than hypercars, this is likely to be much more profitable for Ferrari overall:

Anyone with a few hundred thousand dollars to spare can buy a regular Ferrari as long as they are willing to wait a couple of years. While the standard models aren’t subject to strictly limited runs, the company still lives by Enzo Ferrari’s scarcity dictum: “Ferrari will always deliver one car less than the market demands.”

Limited-edition Ferraris are even scarcer, and you can’t just walk into your local showroom and buy one. These range from special versions of regular models to the design-oriented “Icona” and, most exclusively, once-in-a-decade hypercars like LaFerrari and the F80.

Such models help keep orders flowing for the company’s entire product range even though they account for a fraction of deliveries—just 7% last year. Collectors had on average bought 10 new Ferraris before qualifying to buy LaFerrari or an Icona, which means icon in Italian, according to Hagerty.

Maybe buying a premium Ferrari is conspicuous consumption, and maybe Ferrari is taking advantage of that. However, it is also using its premium Ferraris to increase the price and profitability of a run-of-the-mill Ferrari.

[HT: Marginal Revolution]

The £100 pineapple pizza, and conspicuous consumption

The New Zealand Herald reported yesterday (the original story on the Telegraph is here, but behind their paywall):

It is arguably the most divisive culinary combination.

Topping the traditional Italian favourite with pineapple now comes with a hefty price tag at one trendy pizzeria.

Lupa Pizza, in Norwich, is charging customers £100 ($220) for their Hawaiian pizza on food delivery service Deliveroo because they disapprove of the combination so strongly.

Lupa Pizza is demonstrating their knowledge that demand curves slope downwards. As the price increases, the quantity demanded decreases. A high price of £100 is likely to lead to a quantity demanded of zero. That is, no one buys the Hawaiian pizza.

However, the publicity generated by this stunt may perversely lead Lupa Pizza to sell their absurdly priced pizza. I can just imagine some wannabe social media influencer paying £100 for the memes. Any day now. That would be an example of conspicuous consumption - buying a high-price good simply to signal the wannabe influencer's high status as a purchaser (because who, other than someone of high status, would be willing to pay £100 for a pizza? - see here, for more on that point).

I wonder how much Lupa Pizza's owners would complain when they eventually sell a Hawaiian pizza? Probably not as much as the article would have you believe - the profit margin on a £100 pizza is likely to be substantial (even when you factor in the carrying cost of pineapple as an ingredient that they would rarely use, and probably have to run to the store to get if anyone orders the Hawaiian pizza!).

The pizza may even be underpriced. If lots of wannabe influencers start buying the pizza, Lupa Pizza might need to increase the price even further, in order to really price them out of the market. I wonder what the maximum willingness-to-pay for a Hawaiian pizza is among wannabe social media influencers? We may soon find out.

The consequences of changes in the relative price of wealth and time

In my ECONS101 class this week, we covered some of the basic concepts in economics, one of which is relative prices. The relative price can be simply thought of as the price of one alternative (or one good) compared with another. If both prices are measured in monetary terms, we can calculate the relative price as the ratio of the two prices (P1/P2). However, it need not be the case that the price of each alternative is measured in monetary terms. Regardless of how they are measured, relative prices are important, because changes in relative prices create incentives for decision-makers to change their behaviour. When the relative price of an alternative increases, decision-makers will be less likely to choose that alternative, or will choose to do less of it. When the relative price of an alternative decreases, decision-makers will be more likely to choose that alternative, or will choose to do more of it.

In class, we discussed the role of the relative price of coal and labour in providing incentives for the adoption of less labour-intensive production methods during and after the Industrial Revolution. However, there are any number of other interesting real-world examples of the effect of relative prices. I was particularly interested in this recent post by Tyler Cowen on the Marginal Revolution blog:

Real GDP per capita has doubled since the early 1980s but there are still only 24 hours in a day. How do consumers respond to all that increased wealth and no additional time? By focusing consumption on goods that are cheap to consume in time. We consume “fast food,” we choose to watch television or movies “on demand,” rather than read books or go to plays or live music performances. We consume multiple goods at the same time as when we eat and watch, talk and drive, and exercise and listen. And we manage, schedule and control our time more carefully with time planners, “to do” lists and calendaring. A search at Amazon for “time management,” for example, leads to over 10,000 hits.

As income (and wealth) have increased, the relative price of time-intensive activities has increased. As a result, as Cowen notes, we tend to do less time-intensive activities. Or, we find ways of combining those activities with other activities so that the time cost is lessened. In addition to the examples that Cowen gives, we eat lunch at our desks, we text and drive, and we watch television and scroll through social media. Another way of thinking about this is that the opportunity cost of time-intensive activities has increased - we now give up more income in order to 'consume' time-intensive activities. Like relative prices, when the opportunity cost of an activity increases, we tend to do less of it (in this case, less time-intensive activities). Cowen also makes the following point:

By the way, the same theory also explains why life often appears to unfold at a slower, more serene pace in developing nations. It’s not just an illusion of being on holiday. In places where time is less economically valuable, meals stretch more leisurely, conversations delve deeper, and time itself seems to trudge rather than race. In contrast, with economic development comes an increased pace of life–characterized by a proliferation of fast food, accelerated conversation, and even brisker walking...

'Island time' might be a real thing, with an underlying economic cause. Lower income in developing countries lowers the opportunity cost of time-intensive activities, so people in developing countries do more of them. When the opportunity cost of time is low, being late for a meeting is less costly, both to those who are late, and to those who are waiting. Changes in the relative price of time also explain why the pace of life appears to slow down (for some people, at least) at retirement. The opportunity cost of time for retirees is lower than for working people, and so engaging in time-intensive activities becomes less costly when people retire.

Most of us are not recent retirees though, and we face an inexorable increase in the pace of life, arising from the increasing relative price of time-intensive activities. However, this seems in stark contrast to the 'slow movement' that has arisen in recent years, which advocates for slowing down the pace of life. Adherents to the slow movement are deliberately engaging in time-intensive activities and using more time than is necessary to do so. That doesn't seem to make sense in light of the increasing relative price (and opportunity cost) of time.

That is, until you realise that people in the slow movement may be engaging in conspicuous consumption (of time). Conspicuous consumption is a costly signal of social status (as I've noted before here and here). Only those who are truly wealthy or high status can afford to waste a lot of time on slow food, slow travel, or slow gardening. People in the slow movement face the same opportunity costs of time as everyone else, but they are willing to pay those costs in order to demonstrate their high social status. Think about the celebrities or social media influencers who advocate for the slow movement. I may be wrong, but I don't see too many working-class folk among them.

Relative prices really do matter for decision-making, and changes in relative prices create incentives for people to change their behaviour. And surprising as it may seem, we can sometimes explain important social changes as happening as a result of changing relative prices.

World has just destroyed any premium value for their 'Made in New Zealand' clothing

Following the fallout from the World Made in New Zealand saga (where the New Zealand fashion label World was caught out selling t-shirts with "Fabriqué en Nouvelle Zélande" labels when those shirts were actually made in Bangladesh and Hong Kong), the New Zealand Herald ran a good story on why we're willing to pay for 'Made in New Zealand':

But why would anyone pay $99 for a T-shirt which, it turned out, was materially no different from one sold for a fraction of that price?

When we pay a premium for retail items it's because the branding for that item convinces us it contains some intangible benefit, says Dr Sommer Kapitan, a senior marketing lecturer at Auckland University of Technology.

"Before we knew there was a question about that brand we had this quirky, artistic premium New Zealand fashion brand."

A World shirt was not just a shirt for someone who values artistry or quirkiness, but an expression of those values, Kapitan said.

And the target market for World and most other designer labels were people willing to pay a premium to stand out.

"I [a designer label fan] might not want to see myself as someone who wears $30 stuff. Whether you can tell or not, I want to know that I wear a $100 T-shirt," Kapitan said.

World's decision to write Made in New Zealand in French on its swing tags was an example of the way brands would use symbolic cues to communicate worth to consumers, Kapitan said.

This story, and the explanation, calls to mind two important (and related) concepts from economics. The first concept is hedonic demand theory (or hedonic pricing, which I have written about earlier here in the context of education). Hedonic pricing recognises that when you buy some (or most?) goods you aren't so much buying a single item but really a bundle of characteristics, and each of those characteristics has value. The value of the whole product is the sum of the value of the characteristics that make it up. In the case of a t-shirt from World, you are not only buying a t-shirt, but you are buying something else. As well as the garment, you are buying: (1) the 'warm glow' feeling that you are supporting New Zealand clothing manufacturers; and/or (2) an image that wearing that t-shirt allows you to project to the world ('Look at me! I'm wearing this t-shirt that was made in New Zealand. Aren't I a great person?'). So, people are willing to pay a premium for a World t-shirt that has a 'Made in New Zealand' tag for one or both of those reasons.

That brings me to the second concept - conspicuous consumption (which I've written about earlier here). People engage in conspicuous consumption as a form of signalling - they want to signal to other people the type of person that they are (or the type of person that they want other people to think they are). A signal is only effective if it has two characteristics: (1) it is costly; and (2) it is costly in a way that makes it unattractive for those with 'low-quality' attributes to attempt (in this case, it would have to be unattractive for people who aren't the type of person who buys New Zealand-made to pretend to be that type of person).

With a $100 World t-shirt (with a 'Made in New Zealand' tag), the first characteristic is assured. There is a premium for the 'Made in New Zealand' label, which makes the t-shirt more expensive than a regular t-shirt made in Bangladesh. What about the second characteristic? Assume that there are two types of people: (1) those who really do buy New Zealand-made because they want to support local industry; and (2) those who buy things with 'Made in New Zealand' labels because they want to be associated the first group, even though they don't feel that strongly about it. The first group is (probably) willing to pay a greater premium for 'Made in New Zealand' than the second group, but this can't be assured. Even if the extra cost of buying 'real New Zealand-made' clothing is high, at least some of the second group will not drop out of the market. The signalling value of 'Made in New Zealand' is therefore pretty weak.

The weakness of the signal (and therefore the conspicuous consumption value) of buying 'Made in New Zealand' is also clear because the 'Made in New Zealand' tag is hidden inside the t-shirt. If you wanted people to know that you are the type of person that buys New Zealand-made, you'd want to project that to the world, which is difficult to do if the tag is hidden. So the only way you could present that signal is therefore to buy from a designer where all of their clothing is New Zealand-made (then you don't have to show the label). And this is where World has clearly gotten things wrong. Any signalling (or faux-signalling, given the weakness of the signal) value is going to be lost from World clothing, now that we know they aren't really selling New Zealand-made t-shirts.

Although, that does still leave the 'warm glow' from buying New Zealand-made. But in order to be willing to pay a premium for the 'warm glow', customers have to believe that the 'Made in New Zealand' tag is credible. And World's credibility has surely taken a huge hit. Why would you believe that their clothing is New Zealand-made based on the tag, when the tag has been shown to be worthless in this case? And this is a seriously weak response from World:

But World co-owner Dame Denise L'Estrange-Corbet told Newstalk ZB tags sewn into the garments said "Made in Bangladesh", and stated they were sourced from AS Colour, so it was not misleading customers.

L'Estrange-Corbet said only a small percentage of her products were manufactured overseas.

She said: "99 per cent of our clothing is made here."

So, if the signalling value (which was limited anyway) of World t-shirts has declined, and the 'warm glow' value has declined due to a loss of credibility, that leaves World in a seriously difficult position.

Birkin handbags and the signalling value of Veblen goods

I was recently interesting by this Brooke Unger article published in 1843 magazine last year, about the economics of Birkin handbags. The usual story about very high-end luxury goods (like Birkin handbags) is that they are Veblen goods - goods where the extremely high price is a signal of the high status of the purchaser. This conspicuous consumption can come in many forms. However, when it comes to Birkin handbags it turns out there is more to the story than simple conspicuous consumption:

So-called Veblen goods reverse the normal logic of economics. With most goods, demand falls as price rises; with Veblen goods, the higher the price, the higher the demand, for the more expensive they are, the more effectively they proclaim the status of their owners. The gap between the cost of producing a Birkin and the price tag suggests that it falls into this category.

Yet in a couple of ways, Birkins do not look like classic Veblen goods. First, they’re not all that conspicuous. Almost everyone can identify the provenance of Gucci’s double-G spangled Dionysus shoulder bag; only initiates can spot a Birkin. So Veblen’s theory needs to be adapted to explain the power of inconspicuous but expensive goods. The authors of “Signalling status with luxury goods: the role of brand prominence”, which appeared in the Journal of Marketing in 2010, do so by dividing the rich into two groups: “parvenus”, who want to associate themselves with other rich people and distinguish themselves from have-nots, and “patricians”, who want to signal to each other but not to the masses. They theorise that more expensive luxury goods, aimed at patricians, will have less obvious branding than cheaper ones. Sure enough, they found that Gucci and Louis Vuitton charge more for quieter handbags and Mercedes slaps bigger emblems on its cheaper cars. People who cannot afford luxury but want to look as if they can (“poseurs”) go for big logos: counterfeiters usually copy louder goods.

The interesting bit is that the luxury goods that people buy depend on to whom they want to send signals. Remember that a signal is only effective if it has two characteristics: (1) it is costly; and (2) it is costly in a way that makes it unattractive for those with 'low-quality' attributes to attempt. With a Birkin handbag, the first characteristic is assured. What about the second? One of the ways the second characteristic can be achieved is if it is more costly (in some way) for those with 'low-quality' attributes. Which brings me to this bit from the article:

You cannot walk into an Hermès boutique and expect to walk out with a violet ostrich 30cm bag with palladium hardware, or indeed a Birkin of any description. You have to place an order, and wait. Hélène Le Blanc, then a lawyer working in Paris, was initially rebuffed when she approached the flagship shop in Faubourg Saint-Honoré several years ago. Once she persuaded the saleswoman that she was serious, and willing to wait, she was presented with binders filled with leather samples and hardware options, and allowed to place an order...

In an episode of “Sex and the City” from 2001 Samantha jumps a five-year queue by claiming she wants the bag for actress Lucy Liu.

Yes, the second bit of that quote is fictional, but let's say for argument's sake that celebrities and other sought-after clientele don't have to wait as long to get a bag. The time spent waiting is part of the cost, so if you are an average Jane wanting a Birkin bag, then the waiting time will be longer (and hence the cost for Jane will be higher than for a celebrity).

This bit also struck me:

But as Solca observes, there are good commercial reasons why rationing by queue rather than price can make sense. First, it gives Hermès a buffer: even if demand drops, sales will not. Second, it creates surplus demand for the bags, which overflows into demand for other Hermès products. Much of the firm’s business consists of selling consolation prizes: wallets, belts, beach towels and so on. As J.N. Kapferer of the Inseec Luxury Institute in Paris observes, the wait induces “impatient buyers to switch to other products of the brand, to calm their hunger until the much-awaited object of desire is achieved.”

In ECON100, we talk about selling complementary goods as a way of capturing value and increasing profits, and this is another example of that. Again, the unwillingness to wait for the handbag (and instead buying a belt or beach towel) further demonstrates the signalling value of the handbag itself.

[HT: Marginal Revolution]

Pokemon Go - How much are you willing to pay to catch them all?

It didn't take long for the entrepreneurial to find opportunities to profit from Pokemon Go. The New Zealand Herald reported on Saturday that:

New ads are popping up on Craigslist nearly every day from people who say they will log on to your "Pokemon Go" account and effectively run up your score while you are stuck at work or sitting in class.

On a recent July afternoon, two 24-year-old Pokemon "trainers," Lewis Gutierrez and Jordan Clark, walked through Brooklyn's Prospect Park with their eyes glued to their phones, tapping and swiping away to catch virtual Pokemon for clients paying about $20 per hour for the service.

Of course, this is nothing new. As the article notes, there are plenty of similar offers on online forums from people willing to level up your World of Warcraft characters, or to sell you high level characters.

Would you be willing to pay $20 per hour for someone else to visit Pokestops, catch pokemon, etc. for you? A rational (or quasi-rational) decision maker weighs up the costs and benefits of their decisions. The cost here is $20 (per hour of gameplay). How large is the benefit, and does it outweigh the cost?

First, we need to recognise that there are two benefits to Pokemon Go: (1) the act of playing itself leads to some satisfaction or happiness (not to mention the benefits of physical activity from all the walking around); and (2) the sense of achievement from having a high-level trainer (which might be kudos from your friends, a type of conspicuous consumption). If you play the game yourself, you receive both benefits, but if you pay someone to play for you, you only receive the second benefit.

Now, if we think about the opportunity cost of playing Pokemon Go, we might compare that $20 with your hourly wage (since for each hour playing Pokemon Go, you forego one hour of working). So if your wage is above $20 per hour, then it is lower cost to have someone else play for you. So provided the benefit from an hour of Pokemon Go leveling-up is worth more to you than $20, it makes sense to pay someone else to do it. However, despite these tips for playing at work, or employers who might encourage you to play the game at work, most people wouldn't take time off working in order to play Pokemon Go.

For most people, the choices are: (1) play Pokemon Go and forego the other leisure activity (but receive both benefits); (2) do the other leisure activity and forego Pokemon Go; or (3) do the other leisure activity and pay someone else $20 to play Pokemon Go for you (but receive only the second benefit).

Think about the costs and benefits of the three options. For Option (1), the benefits are the 'activity benefit' of playing (call it B1) plus the 'conspicuous consumption benefit' (call it B2); the opportunity cost is the benefit of the other leisure activity foregone (call it B3). For Option (2), the benefits are B3 while the opportunity costs are B1 and B2. For Option (3), the benefits are B2 and B3 while the opportunity costs are B1 and B2 and $20.

It turns out that, regardless of whether you prefer Option (1) or Option (2), in order for Option (3) to be preferred, then the conspicuous consumption benefit (B2) must be greater than $20, and perhaps much more if playing Pokemon Go is your preferred leisure activity. [*]

So, people who pay others to play Pokemon Go for them are just valuing the conspicuous consumption benefit at more than $20. Make of that what you will.

*****

[*] Pointless algebra time!

The net benefit of Option (1) is B1+B2-B3.

The net benefit of Option (2) is B3-B1-B2.

The net benefit of Option (3) is B3-B1-$20.

Let's first assume that you value the other leisure activity and playing Pokemon Go yourself equally (so B1+B2 = B3). You would be indifferent between Options (1) and (2), because the costs and benefits are equal (and net benefits of both are zero). Would Option (3) be better? The net benefit of Option (3) is B3-B1-$20, which in this case simplifies to B2-$20 (since B3-B1 = B2). So, you would choose Option (3) only if your conspicuous consumption benefit (B2) is greater than the $20 per hour you are paying someone else to play for you. This is also the case if you prefer Option (2) over Option (1), since the difference in net benefits between Option (2) and Option (3) is the difference between B2 and $20.

What about if you prefer Option (1) over Option (2)? In this case, B1+B2>B3. So, B1+B2 = B3+D (where D is the difference in value between the two options).

If Option (3) is preferred over Option (1), then B3-B1-20 > B1+B2-B3. This simplifies to:
B3 - B1 - 20 > (B3 + D) - B3
B3 - B1 > 20 + D
B2 - D > 20 + D
B2 > 20 + 2D

So to prefer Option (3), the conspicuous consumption benefit has to be more than $20 (plus twice the difference in value between playing Pokemon Go yourself and the alternative activity). Note that, holding B2 and B3 constant, the higher B1 is the less likely it is that B2 will be large enough to choose to pay someone else to play Pokemon Go for you.

Can technology save the rhinos?

I've written several posts now on saving endangered species (see here and here and here). Mostly those posts are about the ineffectiveness of proposed interventions, like burning ivory (which increases the price of ivory, and leads to more poaching, not less).

This post is about two of the latest proposed technological solutions for saving rhinos. The first proposed solution is using 3D printing to create and flood the market with fake rhino horns:

A San Francisco biotech startup has managed to 3D print fake rhino horns that carry the same genetic fingerprint as the actual horn. It plans to flood Chinese market with these cheap horns to curb poaching...

Matthew Markus, CEO of Pembient says his company will sell rhino horns at one-eighth of the price of the original, undercutting the price poachers can get and forcing them out eventually...

Susie Ellis, Executive director of International Rhino Foundation says: "Selling synthetic horn does not reduce the demand for rhino horn [and] could lead to more poaching because it increases the demand for “the real thing.” In addition, production of synthetic horn encourages its purported medicinal value, even though science does not support any medical benefits."

This solution has some potential. Fake 3D-printed rhino horn will be a very close (but probably not perfect) substitute for authentic rhino horn (it won't be a perfect substitute because no doubt some buyers would retain a preference for the 'real thing'). Consumers tend to switch from higher-priced to lower-priced substitutes, which would mean introducing fake rhino horn into the market would reduce the demand for authentic rhino horn. Or maybe not.

What if flooding the market with fake 3D-printed rhino horn turns authentic rhino horn into a symbol of high status? Since anyone can buy the cheap fake rhino horn, authentic rhino horn becomes even more valuable than before - essentially it becomes a Veblen good. Veblen goods are luxury goods where the price is a signal of the high status of the purchaser. In this case, when the price goes up people the good is an even more powerful signal of high status, and so consumers who are seeking status demand more of the good. However, one key characteristic of Veblen goods is that they rely on conspicuous consumption - it's no good buying the good if no one knows you bought it. This might be difficult if consuming rhino horn is made illegal, which China has just done.

The second proposed technological solution is attaching hidden cameras to rhinos:

A British team has developed a system to help protect wild rhinos, which could be extinct within the next ten years, because they are hunted by poachers for their lucrative horns.

By using a combination of GPS trackers, heart rate monitors and hidden cameras, wardens can be on site to foil an attack within seconds.

Cameras are embedded inside the horn of the rhino, in what researchers say is a painless procedure.

In theory, embedding GPS trackers and hidden cameras increase the costs for poachers, reducing the supply of rhino horns. However as I've noted before, reducing supply simply increases the price, and increases the incentives for poaching. The higher prices for rhino horn will likely spur innovation on the part of the poachers - how long before poachers would start tranquilising the rhinos so that the camera isn't activated? Or, since we're talking about technological solutions, maybe future poachers start using EMPs to disable the cameras and trackers? Either way, this wouldn't appear to be a long-run solution to rhino poaching.

For rhinos, or elephants, I'm still in favour of farming as a solution.

[HT: Marginal Revolution, here and here]

More on endangered species from my blog :

• Because crushing ivory is so much better than burning it
• Poisoning rhino horns to save the rhinos
• This couldn't backfire, could it?... Ivory burning edition

Are sex services in Russia a Veblen good?

The Moscow Times reports (emphasis added):

In the Urals, sex workers have raised prices by between 50 and 100 percent, Uralpolit.ru said Wednesday, citing unnamed clients of prostitutes.

In addition to the falling ruble, the sex tariff inflation may have been boosted by an influx of sex workers fleeing war-torn Ukraine, the website said. The new competition is forcing local sex workers to hike their rates in order to pay their bills, the report said.

So, there is an increase in the number of people supplying sex services (because of the influx of Ukrainian sex workers), and that leads to an increase in the price of sex services? Only if the demand curve is upward sloping. Otherwise, an increase in competition should lead to a decrease in the price (after all, this is one of the reasons that competition is argued to be good for consumers).

Could the demand curve for sex services be upward sloping? It seems unlikely, but there are some types of goods where the demand curve is upward sloping. One of these types of goods is Veblen goods - luxury goods where the price is a signal of the high status of the purchaser. In this case, when the price goes up people the good is an even more powerful signal of high status, and so consumers who are seeking status demand more of the good. To show their high status, the purchasers then want to broadcast their purchase to many people (especially those who are close to them in actual social status) - this is conspicuous consumption, otherwise the signal is worthless. That doesn't seem a particularly likely scenario for sex services. Neither are sex services consistent with other types of goods that have upward-sloping demand (Giffen goods, goods with network effects, goods with bandwagon effects).

More likely, Uralpolit.ru and the Moscow Times have demonstrated temporary economic illiteracy. Increased supply doesn't increase prices. On the other hand, inflation does increase prices and that is what is being observed.

[HT: Marginal Revolution]

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]