PsychologyMental Model by Joshua Kennon

Mental Model: Veblen Goods

In today’s installment of our mental models catalog, we are going to discuss Veblen goods, which are a special type of item that would appear, at first glance, to violate the law of supply and demand relationships to prices.

Charlie Munger Mental Models

Veblen goods are those that consumers want to buy more of the higher prices rise because they are really purchasing a status symbol that sends a message to friends, family, coworkers, peers and competitors: “I am better than you.”  I personally subscribe to the belief that it is rooted in reproductive signaling theory.

Veblen goods are a type of commodity, product or service for which demand increases the higher the price climbs because buying a Veblen good is seen as a status symbol, giving the purchaser social cachet.  For example, a $10,000 Birkin bag from Hermès is attractive to international celebrities precisely because they want to be noticed.

If the bags were suddenly available at Macy’s for $995 each, many, if not most, of the existing buyers of Birkin bags would not want to purchase them even if they were exactly identical in every respect.  (For those who truly just appreciate the craftsmanship, these products are not Veblen goods because they would still buy them.)

The reason?  When someone buys a Veblen good, they are really buying an item that says, “I am better than you because I can afford this and you cannot.”  It is deeply rooted in human psychology and something known as signaling theory.   Studies have shown that people enjoy a product or service more if they believe it is more expensive.

[mainbodyad]The Austrian School of Economics denies that Veblen goods exist because the entire underlying belief is that people and entities act rationally and economize their resources.  Buying an item due to a higher price doesn’t fit with this model.  Frankly, common sense tells you the Austrian School is point-blank wrong because anyone who has ever watched a group of suburban housewives showing off their new homes or rich lawyers bragging about their yachts knows that the thing they talk about is how much they paid not the product itself.

Veblen goods are related to Giffen goods, positional goods, behavioral economics and signaling theory.

Understanding how Veblen goods work can result in significantly higher profit margins for luxury retailers, jewelers and those selling products that could fit into the realm of a status symbol.  If you want to increase sales, raise prices, don’t lower them.  It is counter-intuitive.

  • Frat Man

    Hi Joshua. Thank you so much for all your help in answering my questions. Because I’m generally responsible with money and do my own investments, sometimes my friends ask me for stock advice, which always puts me in a squirmy situation (if an investment sours, I don’t want to be blamed/lose a friend). My strategy has always been to buy common-sense stocks: i.e. XOM, BRK, CVX, CLX, PG, JNJ, KFT, CL, MCD, WMT, etc. and just watch the dividends increase. But generally speaking, I’m no financial genius- I just monitor earnings, wait for the current or future P/E ratio to hit a sweet spot, make sure the payout ratio of the dividend is sustainable, and then I buy. I’m not really good at delving through annual reports, just because I can’t understand half the jargon in there, and even then, I’m sure they can goose the earnings a bit to satisfy Wall Street’s quarterly estimates. So anyway, long-story short, one of my friends asked me if he should buy Cincinnati Financial. I usually only buy large-cap stocks I’m familiar with, and told my friend thus. But he still wanted me opinion. And since I don’t want to be “on the hook” for this investment, I thought I’d go to you. What are the five to ten criteria that are the most important to you when purchasing a stock? And how much of it is beyond numbers- i.e. hunches and gut feelings? I have read most of your work on, but I was wondering if you could really boil down the numbers you consider to be of the utmost importance. Thanks!

    • Frat Man: You probably shouldn’t have an opinion on 99% of stocks you research. Benjamin Graham said you don’t have to know a man’s exact weight to know he’s fat or a woman’s exact age to know she’s old. Finding value is the same thing; you see an opportunity, it is rare, and you take it if you can afford the risk and it won’t do damage to your standard of living if it goes bust.

      With banks, it comes down to a few really important figures: Total reserves and actual write-offs. A bank sets aside so-called reserves for loans it *THINKS* will go bad. So if we thought $20 million worth of loans wouldn’t get repaid, we’d write that off on the income statement EVEN BEFORE WE LOST A PENNY, lowering profits. Buried in the 10K, we’d have something showing actual net write-offs, which is the amount that ended up going bad. During recessions, conservative banks might take big reported hits by over-reserving and then when things get better, they will “release” the reserve because actual charge offs were much lower. This all goes into the profit column quarters, or years, later and can help them shoot their stock price higher.

      Likewise, tangible capital relative to liabilities matters a lot, too, as does the source of that capital. I wouldn’t touch a bank stock unless I was able to understand all of those figures. That means your friend, unless he is capable of performing that kind of analysis, is gambling not investing.

      Another option for people who want to gamble in “sectors” of the economy, like banks, is focused ETFs, which have all the risk of being concentrated in a single area of the economy and market. For example, the Bank SPDR ETF ( owns a bunch of bank stocks but you buy them under a single ticker symbol. Right now, Citigroup makes up 10% of the holdings but it contains Wells Fargo, Bank of America, Suntrust, Fifth Third, Regions Financial, US Bancorp, JP Morgan Chase, etc.

      As a rule, I never tell anyone if I think something is a good or bad investment. I can’t help you or your friend at all in this regard and cannot make any recommendation. In fact, I think your caution about trading in things you don’t understand is wise! If something is outside of my circle of competence, I run. I may study it to learn for the future, but I don’t feel any pressure to “get it” before time runs out.

      From the little you mentioned, though, I’d say someone who can’t tell whether a loan-loss-reserve-to-net-charge-off ratio is conservative or not within 3 seconds is probably speculating and it will be sheer luck if they make a killing or lose their shirt. If your friend is pushing you for an answer, he will just as likely blame you if things go wrong (and you get no benefit) or he will praise himself for bringing it to your attention (and you get no benefit). So you have NOTHING to gain by talking to him about the stock and everything to lose. Don’t do it. Just change the subject if he asks again or say you have no idea. The danger is not in what you don’t know but failing to recognize what you don’t know. That is where the big money is lost most of the time.

  • Gilvus

    What’s your take on Veblen goods? Would you purchase them?

    • Yes, sometimes. It comes down to two questions:

      1. Do I want the item anyway for its own utility? For example, I always buy the newest, best Apple products. To some people, they are overpriced status symbols. To me, who made a lot of my early money working 18 hours in front of a computer screen, they are far superior tools that I could use because of some of the features built into the operating system that weren’t available in Windows that made my life easier. What is a Veblen good to someone else wasn’t to me. They saved me hours of my life and, as you know, I think time is the most precious commodity. It is far more precious than money.

      Likewise, I buy shirts that are comfortable to me, even though that means I have most of them made to my specifications. I don’t care what anyone else thinks it is entirely and wholly for me. Certainly, those shirts have a Veblen goods price component but I like them better so I buy them.

      2. Do I wish to take advantage of signaling theory? It is a very powerful mental model (signaling theory) and it can lead to a lot of business success. Lawyers in certain areas of law, such as divorce law, are likely to be able to charge higher prices if their offices are in the best skyscrapers with the most expensive books and the most expensive cars. By purchasing and displaying Veblen goods, these lawyers are signaling to their potential clients, “Yes, I’m rich, which means I am successful. And if you want to win your case, you want me on it. Pay my price and you have a better chance of winning.”

      The same can work in reverse. If you walk into the office of a down-to-earth businessman who spent his lifetime building an empire that he is considering selling, he drives a Ford and wears sneakers, and you are in a pair of $800 shoes with Italian cut suits, you may send the signal of “slick banker from the city – not to be trusted”.

      I think the interaction of signaling theory and Veblen goods has not been adequately explored. There is a lot of rich wisdom there that I might write about in the future, now that I think about it …

      • Gilvus

        Behavioral research is difficult because giving a survey to someone makes them a “human test subject.” I’ve been warned repeatedly to not step on the ethical review board’s toes.

        Ever consider getting a guest columnist? Maybe you could ask Dr. Stanley (of “Millionaire Next Door” fame) to share his thoughts. He’s been researching the wealthy since before either of us were born…

  • Dr B

    JK, I don’t think you have refuted any Austrian economic theories here. Praxeological theory simply states that in a voluntary exchange the two parties both expect to profit from it. You’ve made a category error of delving into the psychological realm with your claims here about ultimate causes. If you were more familiar with Mises treatise you would be aware that people act to satisfy ends through the means that they deem appropriate. The ends are non negotiable value judgements made by an individual and the means they select may or may not be suited to achieve these ends. Further, the individual will attach value judgements to the means themselves and some of the means will act concurrently as ends. Your claim that people must “economise their resources” seems to be framed in a mercantilist mindset: the Austrian position is that people seek to maximise their utility. For some this will be to purchase exclusive/expensive items even if others think they are “overpriced” or it is foolish.

    Additionally, like all other “Veblen good” claimants you have failed to provide a satisfactory definition of what they are in reality (and empirical data will not help us reach a definitive definition). Your confusion is demonstrated in the comment that you yourself purchase alleged Veblen goods but you like the products better so they are not Veblen goods to you. All you have revealed is that valuations are subjective and particular to an individual. Austrian economics remains unscathed and perhaps you should read Human Action if you are in doubt.

    • The purpose of this post wasn’t to refuse Austrian Economics; it was a secondary thought. Since you ask, I will say that my objections to Austrian Economics are far more complex, and far more technical, than a general blog post would permit. My throw-away comments on the discipline as regards to Veblen goods were shallow; given my extensive familiarity with it already, and my conclusions as to its inability to work in the real world, I discarded it out of hand, resulting in the appearance of it being based on a feeble objection. It’s much deeper.

      This response is not going to be particularly popular as it is going to touch on several things that people hold particularly dear, but you were honest enough to write me in the contact form asking for a response, so I’ll give you the courtesy of an absolutely frank reply.

      Historical Austrian Economics made valuable contributions to modern economic theory (opportunity cost and marginal utility being brilliant examples). Beyond that, what people call Austrian Economics these days, however, is a body of work of long-discredited refuse that simply does not explain how the real world works nor adequately address some of the mathematical, human, and political problems with which it must contend. In my own experience, people who espouse it do so not because it is the most rational or intelligent model, but because it feels right; it seems good; it appeals to a mental bias known as greedy reductionism. In fact, what passes for Austrian Economics in most circles these days is like misplaced faith – strong on belief, short on facts, absent workable solutions. It reminds me of the abstinence-only debates here in the United States. The mathematical evidence is overwhelming – abstinence only education leads to much higher rates of teen pregnancy and STDs. Yet, people still insist on it based on their belief that it should decrease these things. So they go on feeling rather than fact. It feels right. It seems intuitive. It just doesn’t work with actual human behavior in the actual world.

      While deep, and varied, one of my biggest problems with the Austrian school of thought is the irrationality of its disciples to an adherence to a gold standard, which effectively causes asset prices to be arbitrarily tied to the fluctuating price of a non-industrial metal with a speculative basis that has little intrinsic value. Unlike, say, ammunition or canned food (both of which warrant their own intrinsic merit), gold’s market value is just as “faith based” as fiat currency, the only difference being it is presently limited by terrestrial constraints. Noted economist Irving Fisher correctly pointed out almost a century ago that what such a metal-backed currency does, in practice, is simply convert the price of every good and service in an economy into gold units. Why? “Well, our ancestors thought gold was valuable.” Yes, they also sacrificed their infants to pagan gods of fire; appeal to tradition is another mental bias against which clear thinkers must guard. Simply because something was done does not mean it should be done. Treating gold as the de facto store of value is a pointless, stupid way to behave based entirely on tradition with no intelligent foundation. We could just as well select chicken eggs (which would at least provide more utility).

      Furthermore, there is a mathematical problem that I have never seen adequately addressed that deals with how an Austrian gold-backed system would deal with a global population increasing at a geometric rate when the actual gold supply, due to the very limitations that make it “valuable” in their minds, is increasing at an arithmetic rate. When you are barely adding to the gold supply, but the economy is adding humans on a logarithmic basis, there is no workable solution other than constantly lowering the ratio of gold bullion per dollar (or whatever measurement unit is preferred), which is, itself, inflation in drag; albeit a much reduced version.

      In addition, an Austrian system results in second and third order effects that make periodical liquidations, which have human and financial costs far greater than inflation of all but the most virulent kind (e.g., Weimar Germany) as a result of the fact that many assets, including human capital, have some degree of built-in inflation hedge, but almost nothing can provide a defense against deflationary pressures resulting in a destruction of the outstanding money stock (something that is far more common in a gold-based system). Inflation is another form of taxation; it is not, in and of itself, always fatal or necessarily bad. For example, while inflation ran roughly 4% over the past century causing a single dollar to lost more than 95% of its value, real standard of livings increased by roughly 700%. The fact that currency stores are negative – the longer you hold cash, the more wealth you lose – spurs economic development and activity, changing the opportunity cost calculation for all consumers. A currency that always retained its value exactly on par from year to year would remove this motivation to put money to work and back into the economy, either in the form of increased investment or increased spending. And if stability were valued, on a macroeconomic scale, a gold backed currency is far inferior. (There is also the psychological tendency for people to base their happiness of perceived increases in income; humans, the evidence is abundantly clear, are happier earning $100, $101, then $105, even if that $1 and $5 in years two and three offer no more purchasing power, than they are earning $100, $100, and $100. It’s a quirk of evolution that has implications for public policy if maximizing contentment is a goal of public policy.)

      This is not a carte blanche defense of fiat currency, which can only work when there is some sort of Constitutional provision superseding the power of the legislature to spend more funds than it takes in through taxation and other means (e.g., the so-called “Swiss debt brake” that has done a marvelous job restraining the Federal government in that nation). But if forced to select between the two, a rationally structured fiat currency is always superior.

      In the middle of these extremes is a compromise which I, myself, wouldn’t mind proposed by legendary thinker Benjamin Graham several generations ago that involved backing the currency not by an intrinsically worthless and unstable metal like gold, but by a basket of commodities that had utility to humans, including given measurements of wheat, corn, soybeans, gold, silver, oil, et cetera, mitigating the inherent instability and avoiding the deflationary and population mathematical problems I previously mentioned. This could be a workable solution; one that leaves me with far fewer objections. It wasn’t put into practice because President Roosevelt was worried that he had “already thrown too many rabbits into the economy”.

      Austrian economics is an emotional solution based on feeling rather than fact. It makes its believers feel better about the world; as if they have somehow seen the “truth” and the rest of us, with our university degrees, wealth, and real-world experience running banks and businesses, just don’t get it. Thus, logic-based refutations are often non-effective because the appeal isn’t logical in origin. It’s a cult of sorts; personally, I’ve found all of its adherents particularly likable (for whatever reason) and have quite a few of them around me in my personal life, but it’s all nonsense.

      • Dr B

        JK, your discourse has exposed further lack of understanding of Austrian economic theory. You don’t seem to grasp what money is and how gold came to be the most liquid good on the world market. And your claim that gold has “little intrinsic value” again reveals some probable deficits in your understanding of value. The amount of dollars/goods/services required to obtain an once of gold seem to indicate that it remains a highly valued good. We are well aware that we are not on market selected gold-backed currencies as governments have outlawed it to suit their own inflationary actions. It sounds like you personally don’t like gold but that doesn’t seem to be having much impact on the world market.

        The “basket of commodities” theory is preposterous as there would be no agreement as to which commodities would make up the basket. It is also superfluous when gold had already served the purpose you are interested in.

        I’m intriged that you think Austrian economics is an “emotional solution” when the apriorist methodology is a logical discipline derived from general principles. Are you sure it is not the detractors of the Austrian School that are looking for an emotional solution due to their disappointment at some of the logical conclusions? Can you please let us know where to find the “body of work” that has discredited Austrian economics? Usually I find single sentences (e.g. from Paul Krugman) or paragraphs that deny the validity of the theory but then fail to provide further arguments to substantiate their claims.

        • Paul

          “The amount of dollars/goods/services required to obtain an once of gold seem to indicate that it remains a highly valued good.”

          This is extrinsic value.

        • The reason you find single sentences or paragraphs dismissing it out of hand is the same reason you see people not taking those who believe the world is still flat seriously; it doesn’t warrant serious discussion because you have now generations of accumulated economic data, knowledge, and models that are far superior in explaining some of these phenomenon and, even if you were to attempt to walk through what would amount to a three or four year education in macroeconomics and microeconomics, the listener still wouldn’t grasp it (I’m not speaking about you per se, but my general impression dealing with this in my own life).

          Case in point: The primary objection found in your response was based on a misunderstanding between extrinsic and intrinsic value. If you don’t even understand the differentiation of those concepts, how can we seriously have a discussion on the topic?

          Virtually no one, of any intelligence whatsoever, with any advanced economic knowledge will debate the fact that gold’s “value” is largely set like a Monet. What makes a bunch of paint squiggles on canvas worth $30.8 million? People think it’s worth that. The value is entirely outside of itself based on perception (extrinsic), unlike assets such as silver (which is primarily an industrial metal), ammunition (which can provide defense or tools for hunting), or a 100 acre estate of arable farmland that can produce large amounts of corn, soybeans, sunflowers, hay, barley, tomatoes, potatoes, squash, carrots, radishes, onions, ad infinitum. Even if other people decided the farm has no value, and weren’t willing to pay for the crops, the farm would continue to pump out surplus resources (wealth) year after year, giving it internal (intrinsic) value. It can feed a community, keeping them alive. It requires no economic recognition to achieve this task. It doesn’t matter what the currency does, it doesn’t matter how commodity prices fluctuate, the farm still has some value to the people who own it because they can eat the food, just as they can shoot the bullets, or utilize the silver in a variety of productive endeavors. Gold, in contrast, is worth no more, and no less, than what other people think it is worth. There is no substance there. It’s a limited tool, useful in only a handful of situations.

          Nor do you address even the simple mathematical constraints I mentioned – the entire stock of gold in the world at the moment is around 5.6 billion Troy ounces. Over the past 70 years, new mining has resulted in this keeping pace with the base population, roughly, but the actual economic growth of the world has run about 4x higher than that. Under a gold standard, the only way to accommodate those kinds of increases in economic activity and standards of living would be the inflate by lowering the amount of gold backing each unit of measure (dollar, Euro, etc.), which is still a hell of a lot of inflation. Alternatively, you could keep the gold measurements the same, effectively forcing lower standards of living, at which point adherence to the “faith” of gold is now requiring sacrifices in the form of human felicity. Again, the numbers are so crystal clear that it’s practically axiomatic, yet you provide no solution to something that is foundation to the Austrian school.

          And those were the simple objections based on elementary school math.

          What was your response? Exactly what I predicted – that I simply had a “lack of understanding” of Austrian economics. No mathematical solutions to the clear limitations of your espoused theory. No workarounds for introducing some element of intrinsic value to the currency, rather replacing one faith-based unit for another. It’s like stepping through the looking glass as the queen confidently asserts to a bewildered Alice, “Why, sometimes I’ve believed as many as six impossible things before breakfast!”

          That is why I, and people like me, don’t bother responding to these types of inquiries. It has no hope of succeeding, it serves only to frustrate, and it’s a waste of productive time that could be put to other uses.

        • Dr B

          JK, “intrinsic and extrinsic” value does not tell us anything more than the final valuation that someone reaches. Perhaps a trader feels like these are satisfactorily defined concepts but I’m sure you can see that the dichotomy presents insurmountable problems with how you would categorise all the factors involved (and what purpose it would serve in the market). The philisophical papers pertaining to the concept are interesting but it doesn’t change the thread of this discussion that gold is valued highly.

          I’m not sure why you have a problem with a currency that has increasing purchasing power? It is a non sequitur that inflating a currency is justified as increases in nominal income will apparently provide “contentment”. As you know real wealth is the desired outcome for all. Most of society seem well aware that they need to seek frequent increases in monetary income as the purchasing power of their currency erodes. The contentment would be nothing more than avoiding the discontent of getting poorer.

          Gold was the market’s choice and when it was in use resulted in stupendous gains in standards of living. Are you claiming that we had the appropriate amount of gold supply previously but not currently and how this is defined?

          (And still waiting to hear the explanation of “Veblen goods”…)

        • Pointless. Utterly pointless. It’s like trying to discuss equations with someone who doesn’t know long division; an exercise is futility. I won’t respond further to any of your posts.

          If you feel this way, then the only rational course of action would be to effectively create your own gold standard by hoarding as much as you can as a de facto currency replacement. It’s a stupid way to behave, but by all means, it’s your life.