Mental 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.