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 four 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 third section will consist of the application of these Game Theory priciples to the idea of Conspicuous Consumption, and the final section will identify and briefly explain a number of relvant examples of this type of modeling.

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 it 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 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 many 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 types. The first type of conspicuous consumption is referred to as invidious comparison and the second, more prevalent type is known are pecuniary emulation. Both of these types of behavior 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 than Invidious comparion 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.

Parallels between Conspicuous Consumption and other Behavioral Models

While the above description gives only a brief outline of Conspicuous consumption and its different forms and motivations, there are many parallels one can draw between this type of behavior and other classic instances in which human behavior has been analyzed and modeled. By briefly outlining the ways in which conspicuous consumption can be likened to an Arms Race and examining the types of evolutionary advantages one gains from this type of behavior, the application of Game theory to the concept of conspicuous consumption becomes more clear.

Arms Race Comparison

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.

In addition to the ultimate goal in both an Arms Race and Conspicuous consumption being the same, a relative advantage over other players, the results of the games end up being the same as well. Excess spending on luxury items or military equipment is often done at the expense of other worthwhile expenditures and may not be a socially optimal choice. This imbalance in spending happens under very specific circumstances. As stated by Robert Frank, "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 162). The importance of relative status, or the fact that these expenditures are more context sensitive than many others, will lead to excess spending in both situations. This is a clear parallel between Conspicuous Consumption behavior and the behavior exhibited during an arms race.

Evolutionary Advantage

In addition to the parallels seen between this type of consumption and an Arms Race, one can draw a parallel between these behavioral practices and the theory of evolutionary advantage. One might ask, if this behavior is ultimately inefficient, why then do humans participate in such practices? 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 more "stuff" than others in a group gave an individual 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 and has actual benefits (better jobs, connections, etc.) and may actually result in higher future savings or consumption ability. In this sense, just like other behaviors that have historically given individuals a survival advantage, conspicuous consumption can be a totally rational behavior when viewed in this context. The comparison between historical studies of evolutionary advantages and conspicuous consumption practices further exemplifies the possibilities for drawing parallels in studying consumption behavior and many other important models.

Application of Game Theory to Conspicuous Consumption

The above parallels make it clear that Conspicuous Consumption can be modeled and explained using Game Theory. This, unfortunately, is not an original idea, and has been done in many studies previously. While there are a few different ways this has been done by other researchers, the following section uses an original model to examine Conspicuous Consumption as a Hawk-Dove, zero sum game.

Individuals

In this model, the individuals have two choices: Conspicuously consume ("Consume") or, conversely, save the money that would have gone to conspicuous consumption ("Save"). Payoffs to these actions are as follows:

	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'/'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 (this is what makes it a zero-sum game).

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 is looking up at Player 1's social status.

Player 1 now has less incentive to consume, as the expected payoffs to consumption have fallen, while Player 2 now has more incentive and a higher expected payoff to consumption. So, say Player 2 consumes while Player 1 does not. u₁ now equals .98, while u₂ now equals 1.02. Note that Player 2 actually has a slightly higher level of utility than Player 1. This is due to the fact that Player 1 purchased a certain level of status, then, when Player 2 conspicuously consumed to equal Player 1, this resulted in a decrease of Player 1's relative status. Player 2 is at the status level they expected to be at, but Player 1 is slightly lower. 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)

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. This continues with each player alternately having a greater incentive to consume, however, the incentive continues to be smaller and smaller. This is because each extra "unit" of conspicuous consumption does less and less to affect relative status. The game will continue until the players run out of income or items to consume.

Groups

In the example above, individuals are compared to each other. However, in real life, individuals compare themselves to a much larger societal group. According to Veblen, individuals compare themselves against those in the social group or class immediately above them. All individuals fit into a finite number of social strata (middle class, upper middle class, upper class, etc.) Individuals associate luxury goods with each level of society, and by doing so, form an aggregate mental idea of the goods possessed by the typical member of each social class. They then compare themselves against this average member. The average member of the next social class up from an individual can be seen as Player 1, with the individual in question being Player 2. From there, the game can be modeled for groups in a similar manner that it is modeled for individuals.

Relevance

In Luxury Fever, Robert Frank discusses other situations where the models used to describe conspicuous consumption and arms races can be used, and more importantly, how to prevent these situations from occuring. Here are some of his examples:

Campaign Spending Limits - Both sides can continually escalate spending with no relative gain in results. In an effort to prevent this waste, Congress has enacted spending limits on campaigns.

Zoning Laws - Business could attempt to attract customers with a series of ever brighter, larger, and more noticeable signs. Zoning laws limit the size of signs and control how they are lit.

Roster Limits on Sports Teams - A team could increase its roster size in order to have a fresh pitcher every inning, or a fresh set of substitutes every 5 minutes in a basketball game, as well as increasingly specialized players. Roster limits prevent teams from continually enlarging their roster sizes.

Steroid Bans - If steroids were illegal, it would soon become almost necessary to take steroids to compete on the same level as all the other users. This form of arms race would be incredibly dangerous to the health of athletes.

Hockey Helmets - Hockey players claim that helmets interfere with sight and hearing on the ice, and by not wearing a helmet help increase the chance of their team winning. However, without helmet rules, soon enough everyone would be playing without a helmet, giving no relative advantage to any team, but resulting in far greater health risks.

In addition to these, most forms of cheating follow the rules of an arms race. By one person cheating, it makes the payoffs to cheating higher for everyone (due to a desire to win whatever game they are playing). Soon enough, everyone would be cheating as much as they possibly could in an attempt to gain an advantage.

Other Applications

Special Applications

Bibliography

Bagwell, Laurie Simon and B. Douglas Bernheim. "Veblen Effects in a Theory of Conspicuous Consumption." The American Economic Review 86, no. 3. (June 1996) 349-373.

Bowles, Samuel. Microeconomics: Behavior, Institutions, and Evolution. (New York: Russell Sage Foundation, 2004).

Bowles, Samuel and Yongjin Park. "Emulation, Inequality, and Work Hours: Was Thorsten Veblen Right?" The Economic Journal 115. (November 2005) 397-412.

Frank, Robert. Luxury Fever. (New York: The Free Press, 1999).

Krugman, Paul. "The Mercedes Menace." Available Online at http://web.mit.edu/krugman/www/mercedes.html

Romano, Richard E. "When Excessive Consumption is Rational" The American Economic Review 81, no. 3. (June 1991) 553-564.

Veblen, Thorstein. The Theory of the Leisure Class: An Economic Study of Institutions. (New York: MacMillan, 1899)

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