When Price Dictates Value
How much does something cost? However much people are willing to pay for it. We learn that in Economics 101, where we hear that market prices are dictated by the rules of supply and demand. Consequently, if a price is raised, fewer people will buy it. When prices go down, the reverse is true.
However, there are cases where demand actually increases when prices go up. How come? Do people really want to give up more money to get the same amount of goods? Economists have described two types of goods that exhibit this behaviour.
The first, named after Scottish economist and statistician Sir Robert Giffen, produces this odd behaviour because it is an “inferior” good purchased typically by those in poverty.
Take rice for example, which is seen as less valuable than meat and beans, making it “inferior”. Rice makes up a substantial portion of food spending for much of the world. If the price of rice were to rise, and there weren’t good substitutes like other grains available, many households would have to cut back their spending on more expensive foods like meats. To get enough food, though, they would have to resort to more rice. Here, because of necessity, households would actually be buying more rice after it became more expensive.
On the opposite end of the wealth spectrum and what we’ll focus on is the second type, named after American economist Thorstein Veblen. Veblen goods also contradict the law of demand because they are “luxury” goods. Here, the price of the product dictates the value of the product.
How does this work? Because we are social creatures who live in complex societies, we tend to place value on where we stand within society. Like pecking orders in nature, a higher social standing can give us better access to resources. Or at least can get us into cooler parties.
Luxury goods come into play after our basic needs are met. If we’re not fighting to live another day, we start to ask ourselves, “Now what?” Well how about we spend money we don’t have, so we can pay interest on debt we shouldn’t have. That’s not exactly what people plan, but it’s where many people arrive.
If we place value on where we stand and how we measure up to other people, then it’s something we’ll pursue. But when we don’t go walking around with our bank account balances taped to our foreheads, we need to find a way to signal our wealth to others. Or at least our apparent wealth. We can make others believe we have wealth (and hopefully more than them so we feel good!), whether or not we really have it.
This is called wealth signalling, and this is where luxury goods step in. By making a product more expensive, arbitrarily instead of through providing more functional value, the product’s intangible value can be raised. Luxury goods give people the opportunity to show others that they bought an expensive product. And if they can do that, and maybe pay more money that what it rationally is worth, then they must have lots of money to do so.
La Crème de la Crème
Up to now, several Rolex watches have been sold at auction for over $5 million. I don’t believe any of those watches could provide as much value as 5,682,000 cans of kidney beans , which could go a long way to feeding many people. However, the buyers who put that money down without any intention of reselling believed they were worth that much. They became the sole possessors of their one-of-a-kind watches because they had the wealth to do it. What they bought was a little device that tells everyone just how filthy rich they are.
If wrist decorations aren’t your thing, perhaps sports cars can be your preferred way to broadcast your enormous wealth to the world. You can splurge on the $3 million Ferrari LaFerrari, or opt for the “everyday” Ferrari Portofino new for about $250,000.
Everyday Luxury Spending
Alternatively, you’re not quite that rich, like most of us, and instead make decisions regarding $10 drinks, $50 dinners, and $200 jackets. Every day we make choices about where to eat out next, what clothes to buy, and where we place value. We should take a bit of caution as to our intentions.
Are we finding our decisions motivated by a desire to take care of ourselves and loved ones, or to lead others to think we are wealthy? Maybe you have the money to do both. But many do not, and end up in large amounts of consumer debt to keep up with the Joneses.
Spend Your Money on Your Goals
At the end of the day, spend your money on what you want. But make sure it’s what you really want. Take the time to process your values and determine your own long-term goals and aspirations. These can of course include owning a Ferrari, or buying a fantastic watch, or spending a lot of money on good food. Whatever you aim for, set a plan into action so that you’re not tripped up by short-term tendencies or biases.