April 8, 2013

Competitive Consumption

Economics loves competition. It's what makes the economy go 'round. Without it, markets would fall flat on their faces and buyers and sellers would have their arms twisted into horrendous deals. We'd have to pay even more for our mobile phone service than Canadians do.

Most of the attention paid to competition, though, is about competition among firms. The basic types of market competition in econ101 are types of supplier competition. We worry about monopoly often enough, but who ever lost sleep about monopsony in a consumer market? (the standard monopsony example is a single employer in a labor market)

On the consumer side, it's just assumed that there will be many consumers and they will all want to pay as little as possible. These assumptions are generally true, of course, but they oversimplify things because they gloss over why we consume.

Economics 101 starts with the idea that we have unlimited wants, and then adds on some qualifying assumptions about how we prefer variety and get diminishing marginal utility from any single type of good. The idea of unlimited wants justifies not only what happens in the economy, but how we understand the whole enterprise of economic theorizing. They rationalize endless growth and the focus on consumption and tell us what economic policy is supposed to do: meet our unlimited desires with scarce resources.

This is handy logic, but it only takes you so far. You end up with a lot of consumers who want more of certain things because... well, because they want more of them. Metaphorically, we can think of this model as the "sky's the limit" model of consumption: more is always better. (And if something does start giving you decreasing marginal utility, it just means you want more of something else.) This is the common logic used by economists, but there is less explanatory power here than there might first appear. It does not explain, for example, why happiness does not increase beyond a certain income threshold.

How else are we to understand the motive behind our desires, then? The idea I'll call competitive consumption has some interesting explanatory power, and it also has some far-reaching implications for economic theory.

Competitive consumption is socially-motivated consumption, in a somewhat simplistic want-to-have-more-than-the-other-guy manner. We can also think of it as relative or comparative consumption, or consumption motivated by inequality. Inequality is a powerful motivator, as the right likes to argue. It doesn't have to be somebody getting paid 483 times more than I do, though--just a dollar an hour is enough to drive me into paroxysms of jealousy.

Standard economic theory has developed tools to represent competitive consumption, through ideas like positional goods and prestige markets. But these ideas are seen as exceptions to the norm, when in fact they can be fundamental forces in wide range of markets.

Positional goods are things that we buy because they are scarce--often artificially scarce--and their being scarce confers social status on us. Some goods, like loaves of bread perhaps, are not really positional goods, but most things have at least a positional component. Some are literally positional: a penthouse apartment or a front-row seat. Others are positional because the required expenditure of real resources keeps them scarce, such as weekend ski-trips to Vail or sailing around in giant yachts. Still others are positional because they are kept scarce artificially, like diamonds. Or, like spots in an elite school, by means of reputation and concentration of resources and attention. ?????

Most goods have a positional aspect because that aspect is what motivates, to a large degree, our consumption. Better position is often tied to a real increase in "use value", although economics has as good as given up trying to distinguish what that means. More expensive cars might drive better or more expensive fashion might look better, but these goods are also imbued with social value and that is a powerful reason they are consumed.

Mere quantity can have a powerful impact on positionality as well. Having two or three or four cars can be handy, but it can also show status. Of course, people don't go around saying "I can't believe Rupert only has one car! What a low-class person!" But your kid might hate you if you can't take him to all his after-school activities because your spouse drove the car to work, and the other parents might think you are not a good parent. Use value has its own social implications.

Producers are quite good at exploiting consumers' competitive urges and are able to extract consumer value by providing various "qualities" of a different product that are available at different prices. Alcohol is a perfect example, with quality increasing almost imperceptibly as prices skyrocket. Countless brands also have clearly differentiated models (of cards, computers, headphones, suits, etc...) that are less a reflection of higher costs of production than of the nice infinite ladder of consumer prestige. No matter what your budget is, you can spend it all--and it will never be enough. Part of the reason is simply because we have an extremely wacky (and malleable) idea of what things are worth, but many expensive things have inherent value purely through their expensiveness.

What does it mean to take positional goods seriously and really look at the implications of competitive consumption?

First of all, competitive consumption doesn't mean that consumers are competing to buy a given good--it means that consumers consume for competitive reasons. An extreme conclusion of this idea is that demand can be infinite without increasing welfare. We can consume and consume but our utility, on the aggregate, cannot improve if utility is based on our relative position.

Second, static equilibrium analysis seems woefully inadequate. If goods are positional, then the demand for a good can (and probably does) change every time it is purchased. That is, my purchasing a new BMW might raise the overall demand for BMWs (or lower it, more likely). This is Keynes's "animal spirits" writ large across the entire consumer economy. For marketers this idea may be common sense, but economists rarely take it seriously.

But if we do try to do static analysis, what might our market even look like? A demand curve for a given good is supposed to represent the aggregation of different individuals' "willingnesses to pay", with a few people willing to pay a lot for a good and a lot willing to pay a little for it. So it slopes downward:

Competitive consumption, however, could drive consumers to create that downward slope simply for the sake of having a downward slope. That is, with no variation in preference or anything to do with willingness, demand would still sort itself along a curve reflecting little more than the ability to pay. Everybody wants to be at the top, but they can only get as far as their incomes will take them. (Note that this is looking at demand in the aggregate; assuming consumers have varied preferences, then demand with individual product markets may still be differentiated based on how much consumers want a product. But if we look at all products together we can assume people simply want "more".)

This has important implications for social welfare analysis. Economists generally just look at the area under the curve and call that the social welfare effect. (See the wikipedia article on deadweight loss for some nice graphs.) There are already powerful critiques against this type of analysis (Brad DeLong's "non socratic dialog" is one of my favorites), but if the downward slope of the demand curve is simply an artifact of consumer competitiveness, it leaves welfare analysis on even flimsier footing. If one person's utility is another person's disutility, consumption adds no value.

As mentioned above, the constructed nature of the demand curve is not a passive phenomenon. Marketers understand the competitive nature of consumption and are happy to oblige and encourage consumers' pursuit of utility in a zero-sum game.

Competitive consumption is not the only reason for consumption, but to the extent that it does reflect real motives for consumption it can have real implications for economic theory. And thus also for economic policy. Taking competitive consumption seriously requires us to rethink our ideas about equality and welfare, and the effect of consumption on happiness and aggregate utility. We have built our thinking and our policies on assumptions about human psychology and welfare that are suspect, and we will have a difficult time escaping from our current growth patterns without a better understanding of who we are and what we need. One way to do that is to take competitive consumption seriously.

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