Economists Do It With Models

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On The Economics Of Bling…

November 3rd, 2009 · 15 Comments
Behavioral Econ · Happiness · Markets

Consider the following choice:

Option 1: You make $75,000 per year, the people around you make $50,000 per year.
Option 2: You make $100,000 per year, the people around you make $125,000 per year.

Traditional economic models suggest that this choice is easy- clearly more money is always better, so Option 2 is obviously superior. Yet when this question is posed to actual human beings, a pretty significant number of them choose Option 1. (I tried to find the exact numbers, but Google has for once entirely failed me, so you’re just going to have to trust me here.) Behavioral economists then conclude that people care about how their incomes compare to those of their neighbors in addition to just caring how big the income number is in and of itself, and they reason that this is because social standing is important, yada yada…the phrase “The Economics of Bling” has even been thrown around a few times. As such, I give you the following paper by Kerwin Kofi Charles, Erik Hurst and Nikolai Roussanov entitled “Conspicuous Consumption and Race”:

(Warning: read at your own risk)

Using nationally representative data on consumption, we show that Blacks and Hispanics devote larger shares of their expenditure bundles to visible goods (clothing, jewelry, and cars) than do comparable Whites. We demonstrate that these differences exist among virtually all subpopulations, that they are relatively constant over time, and that they are economically large. While racial differences in utility preference parameters might account for a portion of these consumption differences, we emphasize instead a model of status seeking in which conspicuous consumption is used to reflect a household’s economic position relative to a reference group. Using merged data on race and state level income, we demonstrate that a key prediction of our model – that visible consumption should be declining in mean reference group income – is strongly borne out in the data separately for each racial group. Moreover, we show that accounting for differences in reference group income characteristics explains most of the racial difference in visible consumption. We conclude with an assessment of the role of conspicuous consumption in explaining lower spending by racial minorities on items likes health and education, as well as their lower rates of wealth accumulation.

Okay, let me translate. (Appreantly I am getting good at this.) Some minorities spend a significantly higher percentage of their money on bling than white people do. This can’t all be explained by a simple “black and Hispanic people like bling more” sort of statement, so there has to be something else going on. We develop a model where people are using bling as a signal of wealth, and this model suggests that as the neighbors’ income increases, “keeping up with the Joneses” becomes less valuable (or probably more fruitless), and so we expect to see conspicuous consumption decline as neighbors’ incomes rise (holding everything else constant). This prediction is borne out in the data. Furthermore, if minorities are out buying more expensive sneakers than others, they are spending less on things like health insurance and education, and they are saving less as well.

Actually, Indexed can do you one better:

People like to make more money than their neighbors because it makes them feel richer, and people are sometimes willing to actually be less rich in order to feel richer. Furthermore, as evidenced above, people buy random sh…er, stuff, to make themselves look richer, and this might even make them feel richer as well.

This is all fascinating from a psychological perspective, but could there be a more logistical or practical reason for wanting to make more money than one’s neighbors? I will quote a friend of mine: “Hm…well, one upside of the banking crisis is that it’s much easier to get reservations at Per Se.” She was being (partially) sarcastic, but there’s a lot of truth to the concept. The simple fact of the matter is that prices are determined by the forces of supply and demand, and income is an important determinant of demand. Therefore, when the incomes around you go up, the demand for at least some items that you buy is going to increase, and increased demand leads to higher prices (or shortages). Put more simply, having a bunch of wealthy people around you is going to make stuff you buy more expensive than it would be otherwise. In this way, relative income matters even if people don’t care about status for the sake of status. The down side of being richer than your neighbors is that you might not be able to find the high end goods that you would like to buy (at least not in person), unless you are buying enough Gucci purses and Jimmy Choo shoes to support the entire local market by yourself. And if that is the case, I think I might want to be your friend… 🙂

Tags: Behavioral Econ · Happiness · Markets

15 responses so far ↓

  • 1 Brian G // Nov 3, 2009 at 3:18 pm

    Yeah, my daughter showed me this video yesterday, promoting the ultimate bling: platinum and diamond “grills” for your teeth.
    I could buy a couple of cars for what those things run…

  • 2 Mitch // Nov 3, 2009 at 3:35 pm

    having a bunch of wealthy people around you is going to make stuff you buy more expensive than it would be otherwise

    It sounds like what you’re saying is: part of the reason that some people prefer option 1 (making 75k while neighbors make 50k) is that they have some kind of internalized model of inflation that makes option 2 less attractive (i.e., they expect their real income in the option 2 scenario to be something less than a 33.3% improvement over their real income in option 1). But that seems to me like something separate from concerns about relative status.

    Has anyone tried doing experiments to tease apart those two things?

  • 3 Mitch // Nov 3, 2009 at 3:40 pm

    oops, I stopped to comment before reading your very next sentence, which says what I was thinking. Still, the idea that it’s not just a relative status thing seems to be at odds with this statement from earlier in the post:

    Behavioral economists then conclude that people care about how their incomes compare to those of their neighbors in addition to just caring how big the income number is in and of itself, and they reason that this is because social standing is important

  • 4 Professor Coldheat // Nov 3, 2009 at 3:54 pm

    I’ve had Trading Up in my queue for a while now – not the Candace Bushnell book but the Michael Silverstein one. He talks about the growing tendency of the American middle class to spend exorbitantly on one thing – 42″ HDTV, Callaway golf clubs, California wines – rather than trying to buy everything on the top shelf. It’s “conspicuous consumption” by niche.

    I’ll read it and let you know how it is (although it’s six years old).

  • 5 Steve Myers // Nov 3, 2009 at 4:45 pm

    I think this is simple. We teach that it is relative prices that matter and relative income that positions us. So the answer that the people chose lower actual income, but higher relative income is not surprising.

    What is left unsaid is what is the income of the third group. Group 1 is you, group 2 is the people around you and group 3 is people that are not you and are not around you. If group 3 is large relative to group 2 then they will set the standard of living more than group 2. Then a choice of higher level of income is actually a higher relative income based on group 2 and group 3.

    So if some interpret the answer that group 2 includes group 3 then obviously the best answer is to chose the higher relative income. If group 3 has a lower income than group 2 then option 1 is again preferred.

    Everything is relative.

  • 6 Spencer // Nov 4, 2009 at 7:05 am

    I taught 12th grade econ in AZ for 2 years and surveyed all of my students (about 600) with a similar scenario. I don’t recall the exact number but roughly 80% wanted to have more than their neighbors.

  • 7 p.helix // Nov 4, 2009 at 8:13 am

    Isn’t some of this to do with your relative worth?

    If you are comparing with the people “around” you, that would imply your work, neighbours and/or alumni..

    So, by the fact of this, yuo would always compare what you earn with those around you.
    You want to be seen as valuable/worth more than your “peers”.. you want approval..

    For example.. Its drummed into you at school. You are scored against your peers.
    No one cares what you absolute measure is, but your relative measure.

    You have to retrain yourself to look beyond your peers and at the absolute numbers.

  • 8 Alex Rodriguez // Nov 4, 2009 at 2:21 pm

    What is left unsaid is what is the income of the third group. Group 1 is you, group 2 is the people around you and group 3 is people that are not you and are not around you. If group 3 is large relative to group 2 then they will set the standard of living more than group 2. Then a choice of higher level of income is actually a higher relative income based on group 2 and group 3.

    i’m pretty sure the income of the “third group” is irrelevant considering that by definition each group is completely independent of the other and thus a 3rd group is irrelevant to the study.

  • 9 Alex Rodriguez // Nov 4, 2009 at 6:03 pm

    hey Jodi also this ties in very well with a paper i’m writing, so could you do me a favor and throw in something about relative wealth that’s funny and quotable so i can throw it in my paper? just like a witty and funny example. I have been trying to work your work into my papers (legitimately) for some time now but can never find anything when i need it so the timing on this is perfect, if you would be so kind 😀

  • 10 econgirl // Nov 4, 2009 at 11:28 pm

    Send me an email- econgirl@economistsdoitwithmodels.com with specifics…”be funny” is a lot of pressure! 🙂

  • 11 Noah Roth // Nov 5, 2009 at 11:36 am

    One question is the relative value of money. Perhaps earning $75K while everyone around you ears $50k gives you more real dollar purchasing power than earning $100k (Less valuable USD) while everyone around you makes $125K.

  • 12 holmegm // Nov 7, 2009 at 12:47 pm

    While racial differences in utility preference parameters might account for a portion of these consumption differences, we emphasize instead a model of status seeking in which conspicuous consumption is used to reflect a household’s economic position relative to a reference group.

    Does this mean something like “We don’t want there to be racial differences, so there just aren’t”? Or something else?

  • 13 holmegm // Nov 7, 2009 at 12:47 pm

    Whoops, sorry for the unclosed italic.

  • 14 Joshua // Nov 10, 2009 at 5:47 pm

    This idea seems very holey, and also kinda stereotyping. Let me explain, because I don’t think the folks writing this are racist.

    I’m going to need to see a definition of “conspicuous” consumption, and I’ll be pretty miffed if they don’t consider Lexus, Infiniti, houses over 1500 sq. ft., HDTV, personal jets, horses, etc., as conspicuous as Nikes.

    Of course, A) People often try to look a bit better, and “look” depends upon your community. For some, that “look” is in a shoe, for others, it’s in having your son on the polo team with his own horse. Also, B) as the MU of money for folks decreases with their increasing wealth, they can donate a larger amount of total dollars to “conspicuous” consumption while still spending a lower percentage of their total income. Concept B is why everybody wants to BE rich, and not just look rich (although they always try to look a little richer).

    This is why I would like to see definitions of their most commonly used terms, first and foremost “conspicuous consumption.”

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