WEBVTT - How Do Wine, Cars, and Clothes Defy Economics?

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<v Speaker 1>Welcome to brain Stuff production of I Heart Radio. Hey

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<v Speaker 1>brain Stuff, Lauren bog Obam Here. Let's say you're on

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<v Speaker 1>a first date and anxious to make a good impression.

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<v Speaker 1>The waiter arrives with the wine list, and your date

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<v Speaker 1>asks you to order a bottle for the two of you.

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<v Speaker 1>You know virtually nothing about wine, but you don't want

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<v Speaker 1>to look like an idiot or a cheap skate, so

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<v Speaker 1>you quickly scan the list and point to one of

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<v Speaker 1>the most expensive bottles on the menu. And while yes,

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<v Speaker 1>it is ridiculous to spend a hundred dollars on wine

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<v Speaker 1>that's only marginally more tasty than a twenty dollar bottle,

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<v Speaker 1>it's actually standard human behavior. More than a hundred years ago,

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<v Speaker 1>an American economist named Thorstein Veblen coined the phrase conspicuous

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<v Speaker 1>consumption to describe this very thing. You pick the expensive

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<v Speaker 1>bottle of wine not because it's five times better than

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<v Speaker 1>the cheaper bottle, but because you want to send a

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<v Speaker 1>signal to your date, I have good taste and I

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<v Speaker 1>can afford it. Wine is, to one example of what's

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<v Speaker 1>known as a Veblin good, defined as any good or

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<v Speaker 1>service that defies the standard relationship between price and demand. Normally,

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<v Speaker 1>when price goes up, demand goes down, but for Veblin

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<v Speaker 1>goods like wine, fine art, jewelry, and cars, the rules change.

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<v Speaker 1>We spoke with Ori Heffitt's, an economics professor at Cornell

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<v Speaker 1>University's S. C. Johnson Graduate School of Management. He explained

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<v Speaker 1>the high price is actually part of the attractiveness. In

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<v Speaker 1>Veblen's classic book, The Theory of the Leisure Class, he

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<v Speaker 1>says that high prices have two functions. The first is

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<v Speaker 1>basically marketing. Since winemakers and clothing designers know that most

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<v Speaker 1>consumers don't have the knowledge or interest to figure out

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<v Speaker 1>which products are objectively better than others, they use price

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<v Speaker 1>as a shorthand for quality. Consumers assume, correctly or not,

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<v Speaker 1>that a higher price corresponds to a higher value. The

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<v Speaker 1>second function of high prices is Veblin called conspicuous consumption.

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<v Speaker 1>In this case, the consumer's decision to buy the more

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<v Speaker 1>expensive option has little to nothing to do with the

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<v Speaker 1>actual quality and functionality of the product. The whole point

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<v Speaker 1>is for others to see you drinking the expensive wine,

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<v Speaker 1>wearing the brand name clothes, or driving the fancy car.

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<v Speaker 1>Hefitt said, when other people see me driving an expensive car.

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<v Speaker 1>That's a benefit in itself. They might think that I'm

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<v Speaker 1>more successful or that I'm more desirable as a mate.

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<v Speaker 1>And of course those two functions of high prices often

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<v Speaker 1>work together. And just look at the recent college admissions scandal,

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<v Speaker 1>in which wealthy celebrities were caught trying to buy admission

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<v Speaker 1>for their children into elite colleges. One of the ways

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<v Speaker 1>that schools market themselves as elite is through their high

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<v Speaker 1>tuition costs. If the University of Southern California costs more

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<v Speaker 1>than seventy seven thousand dollars a year tuition plus room

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<v Speaker 1>and board, it must be an amazing education, right. And

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<v Speaker 1>because schools like the University of Southern California use their

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<v Speaker 1>high cost as a signifier of quality, so do parents.

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<v Speaker 1>The wealthy celebrities caught up in the college admission scandals

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<v Speaker 1>were willing to go to a great expense to win

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<v Speaker 1>brand name status for their kids in their social circles.

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<v Speaker 1>Admission to USC is shorthand that their kids are smart

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<v Speaker 1>and successful, which in turn means that they, as parents

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<v Speaker 1>are also smart and successful. Call it the virtuous circle

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<v Speaker 1>of conspicuous consumption. Unless you get caught cheating. Vevlin first

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<v Speaker 1>identified conspicuous consumption among the American upper classes in the

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<v Speaker 1>late eighteen hundreds, but it wasn't until the nineteen seventies

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<v Speaker 1>that economists figured out exactly how it worked as a

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<v Speaker 1>market force. In seventy three, the economist Michael Spence wrote

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<v Speaker 1>a landmark paper on signaling in which he showed how

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<v Speaker 1>our consumer choices send important signals that have real economic repercussions.

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<v Speaker 1>Spence one the two thousand one Nobel Prize in Economics

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<v Speaker 1>by explaining how education is used as a signal for

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<v Speaker 1>produc activity in the labor market. The logic is pretty simple.

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<v Speaker 1>If an employer is looking to hire a new worker,

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<v Speaker 1>he or she will use the status of the applicants college,

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<v Speaker 1>in which tuition cost is variable, as a shorthand signal

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<v Speaker 1>of the applicants relative productivity as a worker. Hefits cites

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<v Speaker 1>the classic example of someone looking to hire a lawyer.

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<v Speaker 1>The assumption is that a good lawyer wins cases and

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<v Speaker 1>therefore has a lot of money. So if one lawyer

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<v Speaker 1>shows up driving a two thousand four Honda Civic and

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<v Speaker 1>the other arrives in a brand new Mercedes, they're sending

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<v Speaker 1>two very different signals. If the client defines a good

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<v Speaker 1>lawyer by how rich here she is, then the Mercedes

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<v Speaker 1>lawyer benefits from conspicuous consumption. Of course, a great lawyer

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<v Speaker 1>could be thrifty, or a lousy lawyer could still drive

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<v Speaker 1>a fancy car. But there's a far higher cost for

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<v Speaker 1>an unsuccessful lawyer to buy a Mercedes. Hefitz said. For

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<v Speaker 1>the good lawyer who actually makes a lot of money,

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<v Speaker 1>the Mercedes is pocket change. It's cheaper and therefore more

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<v Speaker 1>likely for a successful lawyer to send the same signal.

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<v Speaker 1>The larger question is why do we bother with all

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<v Speaker 1>of these signals anyway? Hef It says that there's a

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<v Speaker 1>much more efficient economic solution. Instead of buying a fancy

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<v Speaker 1>car to show how rich you are, you could just

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<v Speaker 1>walk around with copies of your most recent tax returns,

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<v Speaker 1>or introduce yourself to potential clients by saying, hey, I'm

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<v Speaker 1>very wealthy and successful. But of course that's not socially acceptable. Instead,

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<v Speaker 1>people who spend money on flashy cars or clothing can

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<v Speaker 1>hide behind what economists call a functional alibi. If you

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<v Speaker 1>buy a very expensive car, for example, you can claim

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<v Speaker 1>that you didn't do it to send the signal that

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<v Speaker 1>you're rich and successful. But simply because expensive cars run

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<v Speaker 1>better and are more reliable or have better features, have

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<v Speaker 1>it said, But are they so much better that it's

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<v Speaker 1>worth spending twenty times the cost of a good standard car.

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<v Speaker 1>Probably not. Today's episode was written by Dave Ruse and

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<v Speaker 1>produced by Tyler Clang. Brain Stuff is a production of

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<v Speaker 1>I Heart Radio's How Stuff Works. For more on this

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<v Speaker 1>and lots of other economical topics, visit our home planet,

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