Latest / Behavioral Economics with Fexingo: Decision Making, Bias, and How People Really Spend / Why Your Brain Treats a Price Increase as a Quality Signal
Transcript
- Lucas: If I told you a company raised prices by 12 percent and demand went up, you'd probably think I had the numbers backwards. Luna: I'd definitely ask if you meant to say demand went down. Lucas: Right, that's the textbook reaction. But in 2024, Hermès did exactly that with the Birkin bag — raised prices by about 12 percent across the line. And instead of customers balking, their waitlist requests actually increased by 7 percent in the following quarter. Luna: So people actively wanted it more because it cost more? That sounds like the Veblen effect. Lucas: Exactly. Named after the economist Thorstein Veblen, who wrote about 'conspicuous consumption' back in 1899. His argument was that for certain goods, the utility isn't just in using the product — it's in displaying the ability to afford it. So a higher price actually increases the signaling value. Luna: And that's the opposite of what we see with, say, bread or gasoline. A price hike for staples usually kills demand. Lucas: Right. For normal goods, the law of demand holds. But for Veblen goods — think luxury watches, high-end handbags, exotic cars — a higher price can make the product more desirable because it becomes a better signal of wealth. Luna: There's a practical difference between a Giffen good and a Veblen good though, right? A Giffen good is an inferior good where demand rises with price because of a strong income effect — like potatoes during a famine. But Veblen goods are about status. Lucas: Exactly right. Giffen goods are a quirk of necessity. Veblen goods are about luxury and social positioning. The Birkin isn't a necessity. It's a positional good. And Hermès knows that the price itself is part of the product. Lucas: Precisely. And that's why you don't see Hermès discounting. Ever. They'd rather destroy unsold inventory than mark down a bag, because a discount would devalue the brand for every owner. Luna: Quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making episodes like this. If walking through the economy with us has made something click, that's where you can keep it ad-free. Lucas: Yeah, and we don't run ads, so it's the only way the show stays sustainable. Back to the Veblen logic — Rolex does something similar with their scarcity model. Luna: Rolex doesn't just price high, they also restrict supply. You can't just walk into a store and buy a Daytona. You have to build a relationship with an authorized dealer. Lucas: Right. And that scarcity reinforces the price signal. A used Rolex Submariner can sell above retail because the waitlist is so long. So the market price ends up higher than the list price — which is a kind of Veblen double whammy. Luna: There's also the snob effect and the bandwagon effect — they're related but different. The snob effect is when demand drops because too many people have the product. The bandwagon effect is when demand rises because others have it. Lucas: Interesting. The snob effect is actually a counter-Veblen force. If a Birkin becomes too common, its signaling value decreases. Hermès has to balance exclusivity with accessibility to maintain the Veblen effect. Luna: So the price hike is partly a way to filter out less wealthy buyers and keep the product exclusive. Lucas: Exactly. And there's research to back this up. A study by Bagwell and Bernheim in the Journal of Political Economy showed that conspicuous consumption is strongest when the good is visible and the price is known. The Birkin is both — it's instantly recognizable and its price is widely publicized. Luna: What about brands like Supreme? They dropped limited-edition boxes for retail prices that were moderate — like $30 for a t-shirt — but then they'd resell for hundreds on the secondary market. Lucas: That's a different model. Supreme uses artificial scarcity and low retail prices to create hype. The Veblen effect happens on the secondary market, not at retail. The buyer who pays $500 for a $30 t-shirt is signaling status through the willingness to pay that premium. Luna: So the signal isn't just owning the item, but the price you paid for it. Lucas: Right. And that's why some luxury brands have two-tier pricing: a moderate entry price for basics like perfume or small leather goods, and astronomical prices for flagship items. The cheap entry gets people in the door, but the high prices reinforce the brand's exclusivity. Luna: There's also a cultural angle. In some societies, conspicuous consumption is more pronounced. For example, in China, luxury goods spending has grown rapidly partly because social status is closely tied to material displays. Lucas: That's true. And researchers have found that Veblen effects are stronger in cultures with higher income inequality. When the gap between rich and poor is large, people use luxury goods more to signal their position. Luna: It's almost like a status arms race. Lucas: Exactly. And companies can exploit that. Take the smartphone market — a $1,500 iPhone isn't just about better specs. It's a signal that you can afford the latest model. The price itself adds to the value. Luna: But there's a limit, right? If a price goes too high, even Veblen goods can hit a demand ceiling. Lucas: Absolutely. The Veblen effect is not infinite. There's a price range where signaling value increases, but beyond some point, the cost outweighs the benefit. For a Birkin, that ceiling seems to be around $10,000 to $15,000 for the standard models. Limited editions can go higher because they also have scarcity. Luna: So how should a consumer think about this? If you're in the market for a luxury item, should you interpret a price increase as a signal of quality or just a marketing play? Lucas: That's the key question. The answer depends on whether the price increase is tied to actual improvements or just scarcity. If a watchmaker releases a new model with a better movement and raises the price, that's partly cost-based. But if they just raise prices on existing models without changes, it's likely a Veblen strategy. Luna: And for investors, it's important to recognize companies that have Veblen pricing power. Hermès has consistently high margins because they can raise prices without losing customers. Lucas: Right. Their gross margin is over 70 percent. Compare that to a company like Ford, which is around 15 percent. The ability to increase prices without losing demand is a huge competitive advantage. Luna: But not all luxury brands can pull it off. If a brand loses its cachet, price hikes backfire. Lucas: Exactly. Burberry tried to move upmarket in the 2010s by raising prices and burning inventory, but they overdid it and alienated their core customers. The Veblen effect only works if the brand truly signals status. Luna: So the next time you see a price increase on a luxury product, ask yourself: is this about cost, or is it about signaling? And if it's signaling, are you buying the product or the signal? Lucas: And that's a question that goes beyond economics — it's about what we value. As Veblen put it, conspicuous consumption is 'the use of consumption as a means of reputability.' Understanding that can help you make better decisions, whether you're buying or investing.