Everyone wants a taste of luxury

Published 7:30 pm Friday, January 18, 2008

Our American sense of humor often includes some perceptive observations about human behavior. That certainly is true of one piece of wisdom: “Nobody feels sorry for you when your Mercedes-Benz has a flat tire.”

Mercedes-Benz is still considered very much a luxury car, despite its flirtation with so-called “entry-level” cars. And the idea behind withholding any sorrow for Mercedes drivers in distress is that they have incomes high enough to justify envy, not sympathy.

Maybe that is why the reports of disappointing sales by high-end retailers do not make the front page. It is true, though, that sales have slowed at Nordstrom, Coach, Saks Fifth Avenue, and even the queen of luxury brands, Tiffany.

It is understandable that most of us are not exactly teary-eyed about whether people buy fewer of those $1,500-a-pair flirty shoes, designer-enriching suits and gasp-inducing necklaces. But economists do care about this because the decline in sales for luxury goods says something about our economy.

Luxury goods occupy a special place in economic theory; they do not behave exactly the same way as ordinary goods and services.

The law of demand applies to ordinary goods and says that as the price of a particular good or service goes up, people will want less of it. Buried in this simple “law” are many assumptions and sub-theories about behavior, but it actually works for the great majority of goods and services in our economy.

Some goods are more responsive to price changes than others, but most eventually do respond. The demand for oil and gasoline, for example, is generally what economists call “inelastic” — and what we call a necessity — and not very responsive to price changes.

But when the price of oil rises substantially, consumers, over time, do drive less, turn thermostats down, and reduce their consumption.

Over half the reported decline in this past December’s retail sales, for example, was the result of lower gasoline purchases at the pump. It’s really just common sense, and there is a lot more of that embedded in economic theory than is generally believed.

Luxury goods are different in that they generally respond to income changes more than to price changes. The practical effect of this is that if prices are cut, sales volume does not increase enough to offset the smaller amount of cash received for each item sold. That is the economic reason why, for example, most luxury brands do not use discounting to increase their revenue.

What the decline in luxury goods sales is telling us, then, is that for the higher income types who normally buy luxury goods, either their income has declined or that they believe their income will decline. The psychology is every bit as important as the income numbers themselves.

We are learning a lot more about the psychology of luxury goods. The work of Cornell University economist Robert Frank, for example, shed a lot of light on how and why luxury goods are a more significant part of economic activity and have penetrated deeper into our economy — into markets made up of ordinary people with ordinary incomes.

Most of us have been attracted to, or succumbed to, the lure of some luxury brand item. In some cases, we probably understand that it wasn’t “worth it,” in the sense that its higher price was not completely offset by higher quality. Nonetheless, we often enjoy these overpriced articles immensely.

A recent study indicates that our response to luxury goods may not be irrational — at least to the extent that our brains are rational. The research, published by the National Academy of Sciences, found that people preferred wine they thought was higher-priced, even when the prices were fake and simply assigned randomly by the researchers.

More importantly, the response of the wine tasters was not simply wine snobbery, although that might be a factor. By means of brain scans, researchers found that the people drinking the wine actually did enjoy the ones they thought were expensive more than the ones they thought were cheaper. Given the evidence, it is clear that they “talked themselves into it,” convincing themselves that the expensive wines were better — and that became a reality for them.

We would probably not be far wrong if we described economics as the place where markets, politics, technology, and psychology meet — or collide, in some cases. Our economy is certainly a place where our thinking can quickly be transformed into reality. And that is something to consider as we try to keep our footing while buffeted by waves of both genuinely bad economic news and “Chicken Little” reporting.

We may or may not be what we eat; but one thing is increasingly obvious: We are what we think.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.