Sunday, February 12, 2006

The law of demand still holds

If you want to make a point that people are spending more and more on things they do not need (for the purposes of conspicous consumption), do you have to use bad economics to justify your case? Surely not.

In today's Age Sunday Magazine, there was an article about what exorbitant prices people will pay for things. It quoted Clive Hamilton (of the Australia Institute) who has written a book, Affluenza: When Too Much Is Never Enough. He is quoted as saying:

People are prepared to pay more for a product if the price is higher, regardless of intrinsic value. ... Economists think a market becomes more limited as the price goes up but today that is just not true.

Now it is true that economist's tend to believe in the law of demand: as you increase price, fewer people will buy. But this may not be the case for everything. Economists since Giffin have recognised the possibility that in some situations the law of demand may not hold (e.g., if price rises for margarine, people have more to spend and switch from margarine to butter). For other situations, price can be a signal of quality and so firms with high quality goods may not wish to drop prices even when there is excess demand (Joseph Stiglitz won a Nobel prize for that insight, so it is hardly obscure).

However, to say that there has been some fundamental change in the economy so that the law of demand is widely violated is simply not plausible. If so, we would see massive inflation and let's face it, that is not there. We would not see prices fall in the face of competition but we see that all of the time (e.g., telecommunications and computer equipment).

What is true is that firms are using product differentiation -- selling high and low quality versions of a product -- to price discriminate. But it is still the case that as they increase price for the high quality product, they reduce their sales of it.

My point is that the law of demand can work just fine and we can still worry about conspicuous consumption leading to problems. For an example see Robert Frank's excellent book, The Winner Take All Economy (published a decade ago).

Nonetheless, I did find the Age article enlightening on other fronts. For instance, it turns out there is significant demand for Kinder Surprise collections. Before we had children, we engaged in some definitely non-conspicuous, but significant, consumption of these chocolate eggs and have kept most of the toys that came with them. I'll be digging out the collection this afternoon for a visit to eBay to see if I can be surprised further.

2 comments:

hc said...

Joshua, I think your example of a Giffin good isn't clear. Better: If you are a poor person and consume rice 6 nights a week and beef on the 7th then an increase in the price of rice may make it impossible for you to even afford beef on the 7th night so your demand for beef may cease and you buy more rice. Of course there are arguments about whether such a good ever existed -- even Irish potatoes are now rejected as an example.

But I agree with your comments on Clive Hamilton's silly article. It seems he has a particular 'Affluenza' axe to grind will bend the laws of logic when he needs to. Pity, as he has interesting viiews on other issues.

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