Conspicuous consumption: competitive vs monopolistic markets

Conspicuous consumption can be broadly defined as the type of consumption that does not satisfy a direct need or want, but rather, a desire to be regarded as someone that occupies a higher position in a hierarchy. For example, I buy a Picasso not because I particularly like the painting, but because, hanging on a prominent wall of my house, it immediately tells my visitors and friends how wealthy I am. It is this status I seek, not the painting.

The economic analysis of this type of consumption is not easy. One typical mistake is to think that the law of demand is not satisfied, as the higher price of the luxury item is what makes it attractive. The mistake can be understood once one realizes that if the same item could be bought at a lower price (without others knowing that it was bought as a bargain) then the consumer would prefer that.

If the main reason for conspicuous consumption is to buy a place in a ranking, the result is a escalating equilibrium in which those who can afford luxury items will end up consuming too much of these goods. Say that after individuals made their decisions a ranking is established. It is immediate to notice that the same ranking can be established with a much less spending effort (the status-seeking is a zero-sum game). The firms and individuals providing the consumption goods will make a profit, but this is a wealth transfer from consumers to producers. However, the cost of producing these goods is wasted in as much as they do not contribute directly to an increase in utility that deserves the price according to the consumer that buys it. This market failure opens the question about the consequences of different regulations for these goods, like the taxation of luxury items suggested by Stuart Mill in the 19^th century ¹.

There are other ways to consider conspicuous consumption. Instead of buying your place in a ranking, a conspicuous consumption can buy your place in a group. As before, you care about belonging in the group and not about the good. But, contrary to the previous model, this one is not zero-sum, as many individuals can belong in the same club. That is, if one individual spends a sufficient amount of money in conspicuous goods, he or she will be labeled as “rich”, and will belong to the group of people with that label, something he or she enjoys. In this case, the expenditure on the conspicuous consumption can be analyzed within the framework of the signaling models within the Economics of Information. Basically, it says the following: say there are normal and rich people (if we talk about rich and richer people nothing changes), but cannot be told apart. Now we can have the following equilibrium. There is a level X of conspicuous consumption that satisfies the following:

• Everyone in the society will believe that individuals with a level X or higher of conspicuous consumption are rich, and that individuals with a level of conspicuous consumption smaller than X are normal.
• Rich individuals are better off spending X in conspicuous consumption and enjoining the label “rich” than not spending X and not having the label.
• Normal individuals are better off spending less than X in conspicuous consumption, and not enjoining the label “rich”, than the opposite.

In other words: spending X is too expensive for the normal and to be treated as “rich” does not compensate for it. For the rich, the amount X does not mean that much. Now X is not a waste of resources, at least not a total one, as the “rich” individuals get something in return. It may be the case that a lower amount of expenditure satisfies the three conditions above, but that expenditure must be necessarily high in order not to attract the normal individuals.

Within this model, Mandler (2018) ² investigates the theoretical consequences of having piracy versus monopoly in the market for these goods. To understand the insights of Mandlers analysis, consider first the situation in which the level X of conspicuous consumption is achieved buying a few very expensive goods of very well known exclusive brands. The manufacturer of the brand enjoys a monopoly over its use, which means that it can extract a high mark-up, the difference between the cost and the sale price. In this circumstance, a high part of the expenditure X is just a transfer of wealth from the “rich” labeled individuals to the firms offering the luxuriously-branded goods, and a low part is the cost to produce the goods.

Now, if the firm that owns the brand name cannot prevent others from using its name, and if multiple competitors are able to provide a good that is undistinguishable from the original, then the price of goods in that particular brand will decrease, leaving a low mark-up to the manufacturers, both of the original and of the copies. At a first moment, before most people are aware of the existence of the copies, many normal individuals can get the “rich” label at a cost much lower than X, as people will believe that the expenditure in the copies was expenditure in the expensive original brand. This situation, however, cannot prevail. In the end everyone will understand what is going on, and realize that to achieve the level of expenditure X individuals must purchase a much higher quantity of goods or another different set of goods that have not yet been copied. As we saw, in the first case “rich” consumers will be buying a lot from firms with a low mark-up, what means that the proportion of X that is a wealth transfer is low, and the proportion that is a cost is high. In this case, the conclusion is that the total cost to buy the “rich” label is higher in perfect competition (when perfect copies by many copiers are available) relative to monopoly. In the case the “rich” opt to buy other goods, we will have an escalating equilibrium with firms producing goods that are not easily copied. This means the firms will compete to produce goods of higher and higher quality that is costly for other firms to copy. But this also implies a high cost of production and a lower mark-up, with the same consequence of a total higher cost when copies are permitted or tolerated.

In this model, the individuals who consume conspicuously do not care whether the market allows the competence of copying firms or not, as they spend X in any case. It is the monopolistic firms that enjoy higher profits the ones that benefit from the lower cost of providing the same amount of spending in the monopoly case. There is another way of achieving the same social lower cost, namely, allowing competition via copies and imposing a high tax on the luxurious goods. To achieve the social optimal it is enough that the tax plus the low mark-up is equal to the mark-up under monopoly.