Wednesday, July 11, 2012

Why Do We Spend So Much Money on Stuff?

STUFF I LEARNED FROM Robert and Edward Skidelsky's How Much Is Enough? Money and the Good Life

In investigating why people seem to have lost sight of the quest for the "good life" (as articulated by Keynes in his 1930 essay "Economic Possibilities for our Grandchildren"), the authors look for explanations for insatiability and conspicuous consumption. This search leads to the pioneering work of Harvey Leibenstein more than half a century before credit cards and online shopping: "Bandwagon, Snob, and Veblen Effects in the Theory of Consumers' Demand." Here, Leibenstein posits that apart from the "utility" that a good or commodity directly provides--a concept which is at the heart of classical consumer theory--buying decisions are also affected by external effects on utility which the author refers to as the "bandwagon" effect, the "snob" effect, and the "Veblen" effect.

The bandwagon effect pertains to how demand for a good is increased because other people already have it. It is borne partly of conformity--"keeping up with the Joneses"--and partly of envy. Both mechanisms are strong in children, which may cause parents to work harder to satisfy this want, and in individuals and households with limited means or of lower socio-economic standing. Examples include everything your neighbor has which you don't have and makes you salivate.

How do we begin to covet, Clarice?
The snob effect, of the other hand, is the exact opposite of the bandwagon effect: it refers to the extent to which the demand for a commodity is decreased because other people (or too many of them) already own it. It follows, of course, that "snob goods" are desired because others do not have them; they are not necessarily the most expensive, but mark their possessors as having superior taste. This effect represents the desire of people to be exclusive and to stand apart from "the crowd." Examples include everything marketed by Apple.

Despite being polar opposites, snob goods can easily transform into "bandwagon goods," leading to their abandonment by the snobbiest of the snobs.

The Veblen effect (named after American economist and sociologist Thorstein Veblen) overlaps the two effects above: it pertains to the extent to which the demand for a good is increased because it is expensive and known to be expensive. Like bling on your favorite hip hop artist, Veblen goods are simply advertisements of wealth. Examples include everything you don't need and cannot afford.

"I Am Rich." Remember this?

To clarify, there's an important distinction between the snob and the Veblen effect--the former is a function of the consumption of others, the latter is a function of price.

I know how hard it can be to avoid or even just lessen the above effects on our spending decisions: after all, the opinions of people we interact with do matter to some (or a great) degree. Just remember that continuously succumbing to bandwagon, snob, or Veblen effects will just compromise our financial capabilities and delay our journey towards the good life.

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