Tag Archives: Consumption

Consumption Function cake

Many thanks to A2 student Lara Hodgson for this superb cake that the class enjoyed this morning. Remember that the standard Keynesian consumption function is written as follows:

C = a + c (Yd) – where:

  •   C = total consumer spending
  •    a = is autonomous spending
  •    c (Yd) = the propensity to spend out of disposable income

Autonomous spending (a) is consumption which does not depend on the level of income. For example people can fund some of their spending by using their savings or by borrowing money from banks and other lenders. A change in autonomous spending would in fact cause a shift in the consumption function leading to a change in consumer demand at all levels of income. The key to understanding how a rise in disposable income affects household spending is to understand the concept of the marginal propensity to consume (mpc). The marginal propensity to consume is the change in consumer spending arising from a change in disposable income. The higher the mpc the steeper the gradient of the consumption function line. As you can imagine the consumption of cake was fairly rapid.

Consumption cake.jpeg

The Birkin Handbag – is it a Veblen Good?

Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status.

Economists and sociologists often cite the 1980’s as a time of extreme conspicuous consumption. The yuppie materialised as the key agent of conspicuous consumption in the US. Yuppies didn’t need to purchase BMWs or Mercedes’ cars for example; they did so in order to show off their wealth. This period had its origins in the 1930’s with Austrian economists Ludwig von Mises and Fredrick von Hayek – the latter being the author of “The Road to Serfdom”, in which he said that social spending rather than private consumption would lead inevitably to tyranny. Margaret Thatcher (UK Prime Minister 1979-1990) and Ronald Reagan (US President 1981-1989) believed in this ideology and cut taxes and privatised the commanding heights in a move to a free market environment.

So-called Veblen goods (also as know as snob value goods) reverse the normal logic of economics in that the higher the price the more demand for the product – see graph below

VeblenOver the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.

The Economist 1843 bi-monthly magazine had a very good article on Hermès’s Birkin handbag (named after Jane Birkin, an Anglo-French actress who spilled the contents of a overfull straw bag in front of Jean-Louis Dumas, Hermès’s chief executive) and how it has become one of the world’s most expensive – prices start at $7,000; in June Christie’s Hong Kong sold a matte Himalayan crocodile-skin Birkin with a ten-carat diamond-studded white-gold clasp and lock for $300,168. The rationale for its expense is that it is hand crafted and can take up to 18 hours to complete although the production cost is estimated to be around $800.

Birkin Bag

One would think that this would be a Veblen Good – a good in which the higher the price the more demanded. However there are a couple of ways that the Birkin handbag is not.

1. The bag is not all that conspicuous as although most people can identify Gucci, Louis Vuitton or Chanel, a Birkin is not so easy to find. In fact it is an inconspicuous but expensive bag. This theory was explained in the article “Signalling status with luxury goods: the role of brand prominence” from the Journal of Marketing (2010). It divided the high income earners into two groups;

Parvenus – who want to associate themselves with other high income groups and distinguish themselves from those who do not have material wealth.

Patricians –  who want to signal to other people in their high income bracket and not to the masses. They are of the belief that more expensive luxury goods aimed at them will have less obvious branding than cheaper products made by the same company. This was achieved with smaller logos for more expensive items and larger ones for cheaper goods which are aimed at the masses. People who cannot afford the luxury items will buy the big logo items (louder products) and this is where the counterfeiters have a field day.

2. Normally producers of Veblen goods should raise the price till the point where the demand curve starts to follow it normal shape – downward sloping from left to right. However with Birkin they maintain its exclusivity not by raising the price but by limiting the supply. Unlike other Veblen goods you just can’t walk into a shop and buy a Birkin bag – you have to place an order and wait for it to arrive. But you would wonder why they don’t sell more and make more money? It is a supply constraint – limited availability of high-quality skins and craftspeople to make them – it takes two years training. Hermès suggests, Birkins are mined, not simply made.

Commercial Reasons to limit supply of Birkins

Rationing by supply rather than price does make good commercial sense for the following reasons:

1. It gives Hermès a buffer as if demand drops, sales will not.

2. It creates excess demand for the bags, which overflows into demand for other Hermès products – wallets, belts, beach towels etc.

3. Profitability in the short run would reduce its exclusiveness as the main buyers of the bags would eventually be those concerned with social climbing. Therefore the rich may lose interest in the bags and so will those that aspire to be like them.

However I not sure Hermès actually want you to buy their amazingly expensive bag.

Should we stop consumption?

Geoffrey Miller is his book – Spent: Sex, Evolution, and Consumer Behaviour – examines conspicuous consumption in order to rectify marketing’s poor understanding of human spending behaviour and consumerist culture. His thesis is that marketing influences people—particularly the young—that the most effectual means to show that status is through consumption choices, rather than conveying such traits as intelligence and personality through more natural means of communication, such as simple conversation. He argues that marketers still tend to use naive models of human nature that are uninformed by advances in evolutionary psychology and behavioural ecology. As a result, marketers “still believe that premium products are bought to display wealth, status, and taste, and they miss the deeper mental traits that people are actually wired to display—traits such as kindness, intelligence, and creativity.

The recent recession has sent out a few mixed messages. Firstly there has been the reduction in consumption as people’s credit lines have dried up but there are those that believe that you should spend more to maintain growth and employment in the economy. With household budgets being very tight smarter consumption rather than less consumption has been advocated by Geoffrey Miller. He refers to this as more ethical consumption where the production of produce does not involve the abuse of natural resources or the exploitation of people or animals.

The Hedonic Treadmill

The hedonic treadmill is the tendency of a person to remain at a relatively stable level of happiness despite changes in fortune or the achievement of major goals. As a person makes more money, expectations and desires rise in tandem, which results in no permanent gain in happiness. Wikipedia

Below is a very good video on consumption and the externalities it creates. If you are constantly in pursuit of keeping up with others in the community and conspicuously buying, you’re more likely to become addicted to shopping and feel less pleasure and happiness each time you buy. Conversely, reducing your consumption, living more simply, and focusing instead on experiences will ultimately — as this research shows — make you happier. Here is a very good video of this.

China looking at sustainable and balanced growth

Historically China’s economic model was based on export-led growth, massive government injections into the economy and access to cheap money. This is not sustainable and although you can keep blowing up bridges and build cities that nobody lives in at some point it becomes unsustainable. Furthermore since the global financial crisis economies have increased protectionist policies to look after their own economy. Therefore the Chinese government need to refocus the growth of the economy on domestic consumption rather than building things – Gross Fixed Capital Formation. So much more C than I in the GDP Expenditure equation. EG:

GDP = C↑+ I↓+ G + (X-M)

The chart below from the BNZ shows that Consumption ( C ) accounts for just 35% of the Chinese economy which is significantly below what is apparent in the developed world. Domestic Consumption in the US economy is over 70% of GDP. It will take many years for China to get near this level of consumption.

Household Cons % GDP

NZ farmers intending to spend up large

With the Field Days in full swing and primary commodity prices at significant highs there is the expectation that the farming sector will increase its marginal propensity to consume – MPC. Some have suggested that farmers are deleveraging (paying off debt) however cashflows currently appear strong and with the recent payouts farmers seem to have a choice – investment is an option. With such high prices it is important that they “make hay when the shines” (sorry about the pun) so more investment is a strong possibility. In theoretical terms this relates to the Marginal Efficiency of Capital. The theory states that it is profitable to invest so long as the MEC (the % return) is greater than the rate of interest (the cost of funds needed to finance the investment). The OPTIMUM level of Investment is where: % MEC = the rate of interest

From the BNZ rural wrap

In addition, contrary to what some would have you believe, not all farmers have piles and piles of debt. Indeed, some have no debt at all. Indeed, agricultural savings seems to be rising in other ways judging by the $1.2 billion lift in agricultural bank deposits over the past seven months. Unfortunately, the lack of flow of funds or farmer spending data in New Zealand means no firm conclusions around spending can be drawn. But lining up the borrowing and deposit figures against the $3.3 billion increase in annual food exports over the past 12 months suggests some scope for more spending.

Conspicuous consumption

Tonight on National Radio (Radio New Zealand) Brian Crump had a very interesting interview with Dr Neville Bennett, economic historian, University of Canterbury – click here to download the interview. He talked about the change in conspicuous consumption and how people will start to cut back on their purchasing of luxury goods. Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status. A very comparable but more informal term is “keeping up with the Joneses”.

Why do people have this desire to acquire stuff – from the latest model of BMW to designer water?
Over the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth. According to Neal Lawson – author of All Consuming – the central problem of a consumer society is that we might get wealthier, but not happier. Consumers have been competing against each other to gain an advantage. In a race that has no end. Ultimately the competition is about gaining happiness because of someone else’s unhappiness. He describes consumer society as the “the fine art of compensation, enough to reward us and keep our interest but not enough to stop us going back to the shops for more”. However, when is the amount stuff we accumulate enough? According the law of diminishing marginal utility we should find that the first purchase of a product gives us more satisfaction than the second. This means that even if we were to buy more we would look eventually to other ways of finding happiness. If we were to go on consuming we would have to move beyond physical needs to emotional desires.