Conspicuous Consumption and Game Theory

Overview

In this paper we intend to draw a comparison between Thorstein Veblen's theory of Conspicuous Consumption and Arms Races, or the Hawk-Dove game. We believe that Conspicuous consumption can be explained by using these strategic models. The paper will be divided up into three sections. The first section will outline Veblen's theory and discuss the different types of conspicuous consumption. The second section will explain the idea behind Arms Races or the Hawk-Dove Game and outline some of the existing literature on this. The final section will consist of the application of these Game Theory priciples to the idea of Conspicuous Consumption.

Conspicuous Consumption

In most Neo-classical models of the market for goods, it is assumed that price is set by taking supply and demand into account. The market supply curve is a function of the costs of production, and the market demand curve is a function of consumers' preferences and income. It is at the intersection of these two curves that the market will find an equilibrium price. There are, however, a few complications that can arise in this model. The complication that is of interest to us right now is the trend of conspicuous consumption. Conspicuous Consumption is defined as the act of consuming expensive, or showy goods, that are also referred to as "luxury" goods. These goods often are of the same quality as lower priced goods, but offer a societal benefit to the consumer. In this model, higher priced items offer a type of status benefit and are therefore, more desireable. It is, however, important to understand that is not "the price of an object that affects utility directly, or that individuals seek to pay high prices for the sheer pleasure of being overcharged. Rather, [Veblen] proposed that individuals crave status, and that stutus is enhanced by material displays of wealth" (Bagwell 350). In this manner, conspicuous consumption, or the practice of consuming items for the enhancement of one's relative position, alters the typical models of supply and demand by making demand for certain items a function of price.

Thorstein Veblen

The theory of conspicuous consumption is one that has been around for a long time; it was first outline by Thorstein Veblen in 1899. Thorstein Veblen was an American-Norwegian academic who was born in Cato, Wisconsin in 1857. He studied economics at Carleton College but rejected the Neo-classical ideas of John Bates Clark. After earning his undergrad degree he studied under a pragmatist philosopher at Johns Hopkins and continued on to earn a Ph.D. in Moral Philosophy at Yale in 1884. After a few years away from university, Veblen returned to Cornell where he pursued the his previous study of economics further. It was after this final time in school that Veblen began to write. In the very beginning of the 20th century he published a number of influential works. His first book The Theory of the Leisure Class was published in 1899 while he was teaching at the University of Chicago. It was in this book that he introduced and outlined the theory of Conspicuous Consumption. While this theory is the one that is of special interest to us, Veblen did have a number of other noteworthy contributions to the field of economics. Veblen is considered the founder of the Institutionalist school of thought, a perspective that had a large following throughout the 1920's. Institutionalist thought and Thorstein Veblen have made significant contributions to Economics in the last century. As Veblen outlined Conspicuous consumption in The Theory of the Leisure Class, he divided this consumption behavior up into two distinct type. The first type of conspicuous consumption is referred to as invidious consumption and the second, more prevalent type is known are pecuniary emulation. Both of these types of behaving will be further expained drawing on the work of Veblen in the following sections.

Invidious Comparison

Invidious Comparison is a type of conspicuous consumption that occurs when a member of the upper class conspicuously consumes, or makes some type of purchase or investment for its status implications, in order to further distinguish themselves from the upper and lower classes. This type of consumption is done to get an individual further ahead than they already are. In addition to actually getting ahead, this type of investment may be made in order to stay ahead. As Bagwell and Bernheim state, "Members of higher classes voluntarily incur costs to differentiate themselves from members of lower classes (invidious comparison), knowing that these costs must be large enough to discourage imitation" (350). It is for this reason that some individuals may participate in invidious comparison behavior.

Pecuniary Emulation

The second type of conspicuous consumption is much more common that Invidious comparions for a number of reasons. Pecuniary Emulation is defined by Veblen as the tendency of lower class individuals to conspicuously consume or imitate the spending habits of members of the upper class in order to appear to be a member of the upper class. To clarify the differences between the two types of conspicuous consumption, invidious consumption is done by members of the upper class to further signal their high status while pecuniary emulation occurs when member of the lower classes attempt to appear to have a higher status than they actually do. It is important to understand the difference between these two patterns because they have different motivations, and therefore, different implications for the study of the behavior of individuals.

Veblen argued that Pecuniary Emulation occurred more frequently than Invidious Comparison because individuals choose "their work and spending activities in order to be more like a higher income group, rather than seeking social distance from lower income groups" (Bowles and Park 399). He argued that the utility an individual who is already considered a member of the upper class receives from demonstrating a slightly higher status through conspicous consumption (invidious comparison) is far less than the utility a lower class individual recieves from lessening the gap between themselves and the higher status individuals through pecuniary emulation. This difference in utility is the reason that pecuniary emulation is more common than invidious comparison.

TITLE ME

Arms Race Comparison

"For an imbalance to occur in favor of armaments, the reward from armaments spending must be more context sensitive than the reward from nonmilitary spending. And since this is precisely the case, the generally assumed imbalance occurs. After all, to be second-best in a military arms race often means a loss of political autonomy, clearly a much higher cost than the discomfort of having less elaborate outdoor cooking appliances." Luxury Fever, Robert Frank, page 162.

Conspicuous Consumption has often been compared to arms races, in that relative position is the measurement used to determine how well off one is. In an arms race, having the most powerful position is the goal, regardless of if that means having one rifle to another's crossbow, or a nuclear warhead compared to a traditional bomb. The same is true of conspicuous consumption in that having a beat up old car when everyone else has bikes confers a similar advantage to having a Mercedes when everyone else drives a Kia.

Evolutionary Advantage

Why then do humans participate in such behavior? If we did not, we could all experience similar levels of happiness while working less and spending more time with friends and family. Historically, high relative income has conferred reproductive benefits. In particular, throughout most of human history, having the more "stuff" than others in your group gave a very distinct advantage. In addition, the choice individuals generally have to make is between material goods or free time. Having relatively more of both would be the perfect situation, but given a choice between having relatively more material goods or relatively more free time, having more material goods is more likely to aid in one's survival. In addition, there are cases when appearing a member of a higher class acts as a signal of ability has actual benefits (better jobs, connections, etc.) and may actually result in higher future savings or consumption ability.

Application of Game Theory to Conspicuous Consumption

Does Conspicuous Consumption follow a Hawk-Dove model? When modeling this, the individuals have two choices: Conspicuously consume ("Consume") or, conversely, save the money that would have gone to conspicuous consumption ("Save").

Payoffs to Conspicuous Consumption:

	Consume	Save
Consume	(-5,-5)	(2,-2)
Save	(-2,2)	(0,0)

The values above are arrived at based on the following: Conspicuously consuming carries a cost, but gives utility provided others do not follow the same course of action. Thus, when both players Conspicuously Consume (a 'Hawk' action) they suffer losses from expended income that brought no advancement in social status. When one player consumes and another does not, the consumer receives a gain in utility from advanced social status (which is greater than their expenditure), and the player who did not consume falls in relative social position. When both do nothing, everything remains the same. In this game, any benefit to one player is accompanied by an equal loss in utility for the other player.

One feature of major importance in conspicuous consumption "arms races" is that each round of conspicuous consumption changes the payoffs for future interactions. For example, in a two player game, if in the first interaction Player A conspicuously consumes, but Player B does not, in the next "round" of the game, Player B has a greater payoff to conspicuous consumption, and Player A has a lesser payoff. This is because the relative gains from conspicuous consumption have shifted.

These can be modeled by changing the payoffs of the game. Assume that u₁ represents Player 1's utility, and u₂ represents Player 2's utility.

Assuming the two start as equals,

u₁ = u₂ = 1

Note that for future games,

(u₁ - u₂)/c = j, where c is a constant describing the desire for status.

The payoffs might look like this:

	Consume	Save
Consume	(-.25,-.25)	(.1-j,-(.1-j))
Save	(-(.1+j),.1+j)	(0,0)

which, when u₁ = u₂, gives the following:

	Consume	Save
Consume	(-.25,-.25)	(.1,-.1)
Save	(-.1,.1)	(0,0)

Now say in this interaction Player 1 decides to conspicuously consume, while Player 2 does not. Player 1 receives a payoff of +.1, while Player 2 recieves a payoff of -.1. u₁ is now 1.1, and u₂ is now .9. Using 10 (arbitrarily chosen) for c results in j = .02. The payoff matrix now looks like this:

	Consume	Save
Consume	(-.25,-.25)	(.08,-.08)
Save	(-.12,.12)	(0,0)

What has happened here is that Player 1, by virtue of already having a higher status than Player 2 through previous conspicuous consumption, now has less to gain from consuming. As Player 1 is already the one with the highest status, further conspicuous consumption does not do as much to elevate his/her status. Player 2, however, has much more to gain, by virtue of being of lower relative status. Should Player 2 conspicuously consume and Player 1 not, he/she will experience a greater gain. This is also true because of the fact that, according to Veblen, conspicuous consumption is largely done through the process of pecuniary emulation, that is, those with lower social status looking up at those above them, in this case, Player 2 looking up at Player 1's social status. LOSS AVERSION?!?!?!

Player 1 now has less incentive to consume, while Player 2 now has more. So, say Player 2 consumes while Player 1 does not. u₁ now equals .98, while u₂ now equals 1.02. Using the same c as before gives us j=.004. The payoff matrix now looks like this:

	Consume	Save
Consume	(-.25,-.25)	(.1002,-.1002)
Save	(-.0998,.0998)	(0,0)

This model assumes that conspicuous consumption is done in single equal units - if so, why , after both have conspicuously consumed once, does Player 2 have an advantage in terms of overall utility? The reason is because of loss aversion. The loss in relative status for Player 1 results in a greater loss in utility than the subsequent gain in status causes in terms of utility gained for Player 2. This also has the affect of making it attractive for Player 1 to conspicuously consume again, or, were this an arms race, to build more weapons.

Bibliography

by Rebecca Kealoha Breeden '06 and Matthew Emerson Davis '06