Categories
Uncategorized

A Game Theory Approach to Veblen Goods

Introduction

In the past few years, some people have seen a very significant growth in their bank accounts within a relatively short period of time through starting a new business during the pandemic, having good timing in the cryptocurrency market, or landing a high-paying job. With many of these people being new to having more digits in their accounts, it’s only natural that some want to celebrate or show off their newly found success by purchasing Veblen goods. For those unfamiliar with the term, Veblen goods are goods that see increasing demand as prices increase. Examples of these goods include designer clothing, exotic cars, and expensive timepieces. Veblen goods work the opposite way of how most consumer goods do since normal goods see a decrease in demand as prices increase. Veblen goods are highly sought after because they are seen as status symbols. This is due to their exclusivity, which is a direct result of their high price tags. Please note that this blog post is not meant to offend those who desire such luxury goods, especially since I see the appeal myself.

 

Game Theory Approach

To understand the pricing of Veblen goods, we can take a game theory approach to analyze the decisions of both the consumer and the company selling the goods. Note that the consumer in this case is not the average consumer of goods, but rather the target customer of these Veblen goods who are consumers with a decent chunk of change and the desire to own these status symbols. On the consumer side, the possible strategies are to buy or to not buy. On the company side, the possible strategies are to price the product high relative to the manufacturing costs or to price the product significantly higher than the manufacturing costs. The payoff for the consumer is how superior they feel for owning the good. For this example, let’s define the consumer payoffs as follows:

  • 0 when not buying the high price product since they don’t feel superior at all
  • -1 when not buying the significantly higher priced because they feel unpleasant by not owning such a high status good
  • 5 when buying the high priced product
  • 10 when buying the significantly higher priced product

On the company side, the payoff is how much they make in profit. In this example, let’s say the manufacturing cost is $500, the high price is $5000, and the significantly higher price is $10000. Then, the company payoffs are as follows:

  • -500 when the consumer does not buy
  • 4500 when the consumer buys at the high price
  • 9500 when the consumer buys at the very high price

Here is the payoff matrix for our example:From the matrix, we can see that the consumer has a strict dominant strategy since the payoff is higher from choosing to buy regardless of how the company prices the product. We can also see that the company has a dominant strategy since the payoff from pricing significantly higher is a strict best response when the consumer buys but only a best response when the consumer does not buy. We can conclude that the consumer will be happier buying the products, especially if the product is priced very high, and the company will be happier pricing the products significantly higher. Using this game theory perspective on the pricing of Veblen goods allows us to visualize and logically demonstrate why companies prefer to price luxury goods very high.

 

Conclusion

In conclusion, Veblen goods are a very unique type of goods in that their demand increases when prices are higher, which contrasts from other consumer goods. However, the demand is considered only from the target customers who find joy in status symbols and exclusivity. Taking a game theory approach to analyze the decisions of the target consumers and the luxury companies proves that it is in the companies’ best interest to price the products unreasonably high to the general (non-target) consumer since the target consumer would get more joy from the elevated exclusivity of the product.

 

Sources

What is a veblen good? veblen goods and the law of demand – 2022. MasterClass. (2022, October 11). Retrieved November 7, 2022, from https://www.masterclass.com/articles/veblen-good

Leave a Reply