Oh no, not another Veblen good…

It seems that upward sloping demand curves (see ‘Veblen’ and ‘Giffin’ goods) have the tenacity of cockroaches and Area 51 conspiracy theories; the possibility of positive correlation between price and quantity demanded simply refuses to die.

The basic idea of a good with an upward-sloping demand curve is that a higher price somehow incentivises consumers to buy more of the good. For example, Thorstein Veblen (incredibly depressing economist from the early 1900s) put forward the concept of ‘conspicuous consumption’. He saw, during the ‘Roaring Twenties’ period of high growth and newly-made millionaires, that there was a tendency for the ‘leisure class’ to purchase goods with ‘show appeal’, e.g. luxury items that would show off the wearer’s wealth. He went on to posit that the appeal for such goods was greater the higher the price, assuming that onlookers were aware that the good had risen in price. Hence; inverted demand curve.

In many of my colleagues’ opinions, the upward sloping demand curve does exactly what we try to hammer into our students not to do; it confuses cause and effect and hence does not distinguish between “movement along” and “shift” in the demand curve.

Simply put, for an upward sloping demand curve to exist, there must be direct causality between price and quantity demanded – e.g. a change in price leads to increased quantity demanded for the good. However, it is more than likely that previous or on-going increases in price lead to – cause – an increase in demand. In other words, expectations of higher prices for goods subject to speculation (houses, gold and shares) lead to an increase in demand! It is this increase in demand that subsequently drives up the price of the good. In summa: it is not necessarily a price increase which causes an increase in demanded quantity but quite probably the reverse, i.e. an increase in demand (due to expectations) leads to an increase in price. Price is determined by demand – not the other way around.

For reasons unknown, students are absolutely fascinated by the concept of an upward-sloping demand curve. I checked past IA scripts and found that around one tenth of all scripts dealing with micro had at least a reference to Veblen goods – every example used in these IAs was garbled, confused or outright erroneous. Quite frankly, both I and colleagues are quite grateful to have this confusing nonsense removed from the latest  syllabus!

An article in the Independent (UK) recently peaked my interest about two things I often put some time and effort into combating; sloppy economics and pretentiousness.The article brought up a recent test where participants were asked to grade different wines according to ‘taste/quality’.

Let us assume the following:

1. Wine drinkers can differentiate between wines and grade them along a ‘tastiness curve’ – where ‘tastier’ means ‘higher quality’.

2. Wine drinkers will generally be willing and able (i.e. we are dealing with effective demand!) to pay more for a higher quality wines.

The article gratifyingly pointed out that in a blind survey of different wines (where the tasters were not shown the label, name or price), there was zero or even negative correlation (e.g. the cheaper the better!) between price and perceived tastiness of the wine. This held broadly true even for professional wine judges. (See article at http://i100.independent.co.uk/article/why-theres-really-no-point-in-buying-expensive-wineunless-youre-a-connoisseur–gJeX2q2mtWb)

HOWEVER; there was positive correlation between price and perceived tastiness when the tasters knew the price and/or quality label! Now it gets interesting……and here it is I who shall possibly be guilty of sloppy economics – or at least of muddying the causality waters.

Assumption one above evidently does not hold true. How about assumption two? Well, hmmm, yes…and no. Perhaps. It seems to depend on the drinker knowing the price of the good to determine whether they were willing/able to buy the good! A most circuitous argument in fact, where basically the buyer can only gauge the quality of the good by knowing the price…and the price willing to be paid would be based on the perceived quality of the good. That’s the main problem; when buyers do not have the skills or experience necessary to correctly estimate ‘value’, they rely instead on ‘perceived value’ – and this is frequently given by simply looking at the price. In essence, should we be able to measure the strength of this connection (price causing perceived value to increase and thus increased willingness/ability to buy the good) and indeed prove that a higher price causes increased demand, we would have a Nobel Laureate-winning example of a Veblen good.