BMO6630 - Literature Review on Conspicuous Consumption & Satisfaction

This assignment provides a literature review focusing on conspicuous consumption and its impact on satisfaction, particularly within the context of luxury goods and status. It references a working paper that explores the envy-related welfare loss from conspicuous consumption, using luxury car consumption (Ferraris and Porsches) in Switzerland as a case study. The paper uses household panel data and fixed effects panel regressions to suggest that the prevalence of luxury cars in the municipality of residence has a negative impact on income satisfaction. The review also touches on modeling conspicuous car consumption and the empirical literature surrounding consumption externalities, including the demand for conspicuous consumption and its signaling motives. The review aims to quantify the presence and size of consumption externalities by examining the effect of conspicuous consumption on others' satisfaction, drawing from research in behavioral economics and consumer behavior.

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Winkelmann, Rainer
Working Paper
Conspicuous consumption and satisfaction
Working Paper, No. 30
Provided in Cooperation with:
Department of Economics, University of Zurich
Suggested Citation: Winkelmann, Rainer (2011) : Conspicuous consumption and satisfaction,
Working Paper, No. 30, University of Zurich, Department of Economics, Zurich,
http://dx.doi.org/10.5167/uzh-51534
This Version is available at:
http://hdl.handle.net/10419/77507
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Conspicuous Consumption and Satisfaction
Rainer Winkelmann ∗
University of Zurich, CESifo and IZA
August 2011
Abstract
Traditionaltools ofwelfare economics identify the envy-related welfare loss from
conspicuous consumption only under very strong assumptions.Measured income and
life satisfaction offers an alternative for estimating such consumption externalities.The
approach is developed in the context of luxury car consumption (Ferraris and Porsches)
in Switzerland.Results from household panel data and fixed effects panel regressions
suggest that the prevalence of luxury cars in the municipality of residence has a negative
impact on own income satisfaction.
JEL Classification:D12, D62, I31
Keywords:Ferrari, Porsche, status, consumption externality, Swiss Household Panel
∗Address for correspondence:University of Zurich,Department of Economics,Zuerichbergstr.14,CH-
8032 Zurich,Switzerland,email:[e-mail].I thank Holger Bonin,Andrew Oswald,
Kevin Staub,two anonymous referees and seminar participants in Bayreuth,Bamberg,Glasgow (Annual
Meetings ofthe European Economic Association 2010,Fraser ofAllander Institute,2011) and Lausanne
(Workshop in Redistribution and Well-Being) for helpfulcomments,Oliver Lipps for support in obtaining
the data, and Wishiro Keo for excellent research assistance.

1 Introduction
There is ample evidence that individualwell-being is affected by comparisons with others.
Status concerns are an important feature of our social existence.Higher ranked individuals
are on average healthier (Wilkinson,2000,Marmot,2003) and live longer (Oswald and
Rablen, 2008) than lower ranked ones.They also report higher levels of happiness in survey
questions (Di Tella at al., 2007).Relatedly, actions of others provide a “frame of reference”
for own decisions (Frank,1991).As Karl Marx (1847) famously noted,“A house may be
large or small;as long as the neighboring houses are likewise small,it satisfies allsocial
requirement for a residence.But let there arise next to the little house a palace,and the
little house shrinks to a hut.”
For the economist, such positional concerns and frame of reference effects are importan
as they can lead to inefficient market outcomes.For example, resources spent on improving
one’s status are wasteful from a societal point of view, as one person’s gain is another pers
loss. As Layard (1980) puts it “For,though individuals are willing to make sacrifices to
improve their individual position, the net result of status-motivated action will be no increas
in status satisfaction but an increase in sacrifice.” (p.738).Perhaps the best studied example
of such wasteful competition occurs in the presence of relative consumption effects, i.e.if an
individual’s utility depends not only on the levelof her own consumption but also on how
that level compares with the consumption of others.
One cause of such interdependence has been explored by Veblen (1899) who, referring
the behavior of the nouveau riche during the Second Industrial Revolution in Britain, coined
the term of “conspicuous consumption”.He argued that this consumption “is evidence of
wealth, and thus becomes honorific, and .. . failure to consume a mark of demerit.” Veblen
thus singles out consumption that is intently used as a signalfor status. More broadly,
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conspicuous consumption refers to any consumption activity that is, first, literally “visible”
to outsiders,and, second,positional,in the sense that own consumption utility depends
partly on relative rather than absolute consumption.
Despite the obvious interest for microeconomic theory (e.g.Layard,1980,Dupor and
Liu, 2003,Arrow and Dasgupta,2009),and the widespread reference to the concept in
the economic literature, there is surprisingly little direct empirical evidence on the effect of
conspicuous consumption on well-being of others.The objective of this paper is to contribute
such evidence within the context of the life satisfaction literature, in order to provide direct
empirical quantifications of the presence and size of consumption externalities.I propose to
use information on what people say when asked whether they have a good and worthwhile
life, i.e., survey information on “subjective well-being”,“satisfaction”,or “happiness”,in
order to estimate the effect of conspicuous consumption on others’ satisfaction, and thus th
utility loss due to such consumption.The empiricalapproach using satisfaction equations
is in the spirit of previous papers concerned with the valuation of intangibles, including van
Praag and Baarsma (2005) on the cost of airport noise, Luechinger (2009) for air quality an
Frey et al.(2009) for terrorism.
This paper focuses on a specific instance of conspicuous consumption, the purchase and
display of luxury sports cars in Switzerland.Two brands are considered, Ferrari and Porsche.
These are the two main automobile producers present in the Swiss market that specialize
in the upper segment ofluxury sport cars.The demand for these cars has increased over
the recent decade.Whereas totalsales ofnew cars declined between 2001 and 2007,new
registrations of Ferraris and Porsches increased by almost 80% (in 2008,the numbers went
down, see Figure 1).The consequence was a doubling in market share of such luxury sports
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cars among all newly registered cars from 0.4% in 2001 to 0.8% in 2007.
− − − − −− Figure 1 about here − − − − − − −
The empiricalapproach in this paper combines information from various sources.Indi-
vidual level satisfaction (with income and with life in general) and other socio-demographic
characteristics (most importantly current household income) are obtained from the 2002 an
2007 waves of the Swiss Household Panel.In a second step, regional information is matched
to each person-year observation.The first, obtained from the Federal Roads Office, provides
the number ofnew luxury car registrations (Ferrariand Porsche per 1000 population and
year) in the municipality and canton of residence.1 The second,obtained from the Federal
Tax Administration, includes information on average incomes and income inequality, again
for each municipality, canton and year.
The statistical hypothesis being tested is that income and life satisfaction are not related
to the localor regionaldensity of new luxury sport cars,ceteris paribus,against the alter-
native that there is a negative association.The empirical analysis employs linear regression
models with fixed individual specific as well as region specific effects.
2 Background
2.1 Modeling conspicuous car consumption
The following model,an adaptation of Dupor and Liu (2003),provides a usefulframework
for thinking about conspicuous car consumption.Let c denote own consumption ofcar
attributes (such as horsepower,or looks) and ¯c the average attributes in the population of
1A municipality is the smallest administrative and politicalunit in Switzerland.Depending on size,it
can be a village, town or city.
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cars.The utility function of identical consumers can be written as
U (c, ¯c, x) (1)
where x is a non-conspicuouscomposite good.Suppose thatpeople enjoy horsepower
(∂U/∂c = U1 > 0) as well as non-conspicuous consumption (∂U/∂x = U3 > 0), that
marginal utility is diminishing (∂2U/∂c2 < 0, ∂2U/∂x 2 < 0), and that horsepower consump-
tion is conspicuous and generates envy (∂U/∂¯c = U2 < 0). People then choose c and x in
order to maximize utility subject to the budget constraint
c + px ≤ yf
where yf is income at full employment and leisure is part of x.Substituting the constraint
into utility function (1), individuals thus maximize
U (c, ¯c, g(c))
where g(c) = (yf − c)/p.They take public consumption ¯c as given and trade off the marginal
utility from own conspicuous consumption with the marginalutility from non-conspicuous
consumption.The first-order condition for a maximum is
U1(c, ¯c, g(c)) + g0
(c)U3(c, ¯c, g(c)) = 0 (2)
or
1
p = U1(c, ¯c, g(c))
U3(c, ¯c, g(c)) (3)
It is a-prioriundetermined whether public consumption ¯c affects the solution to (3),and
hence what the optimal own consumption levels for c and x are.For example, the marginal
rate of substitution between conspicuous and non-conspicuous consumption is independen
¯c if the utility function is either additively separable, or multiplicative (e.g.of Cobb-Douglas
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form) in ¯c. In these cases, envy has no behavioral consequences although it lowers a person
utility.In other cases, consumption comparisons can lead to behavioral responses.Suppose,
for example,that an increase in ¯c raises the marginalutility ofconspicuous consumption
relative to that of non-conspicuous consumption.As a consequence, it is optimal to reduce
non-conspicuous consumption (including leisure, i.e.work more, for example) and to increase
own conspicuous consumption.In such a case, it is in principle possible to infer the presence
of a consumption externality from observed behavior.In general,behavioraldata cannot
prove the absence of envy effects for the stated reasons.Suppose instead that U (c, ¯c, g(c))
can be measured empirically.Then it becomes possible to determine the effect of ¯c on U , if
any, using statistical methods.
Learning about such envy effects is important from a policy perspective, as they result in
an inefficient allocation in general,and “overconsumption” in particular.To see this,note
that in a symmetric equilibrium with c = ¯c, we obtain
U1(c, c, g(c)) + g0
(c)U3(c, c, g(c)) = 0
This equilibrium is inefficient,since individuals do not account for the negative externality
U2(c, c, g(c)) they impose on others.The social optimum requires that
U1(c, c, g(c)) + U2(c, c, g(c)) + g0
(c)U3(c, c, g(c)) = 0 (4)
Assuming concavity ofU (c, c, g(c)),the optimalcar consumption c∗ that solves (4) is less
than equilibrium consumption,an instance of overconsumption.A government imposing a
luxury tax can remove or alleviate this inefficiency.
The underlying assumption ofidenticalconsumers is admittedly unrealistic,as every
person would then buy cars with similar attributes, whereas in reality Ferraris and Porsches
are only bought by few people.Changing the modelin order to allow for heterogeneity in
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endowments (whereby “rich” people would have a greater demand for c) would not change
the essential mechanisms leading to overconsumption.
2.2 Empirical literature
Consumption externalities involve two parties:those who generate them and those who
are affected.There are a number ofrecent empiricalstudies regarding the first group of
people, i.e., the decision of, and demand for, conspicuous consumption.Johannsson-Stenman
and Martinsson (2006) study the perceived importance of status concerns in consumption
decisions.Charles et al.(2009) show that Blacks and Hispanics devote larger shares of
their expenditure bundles to visible goods (clothing, jewelry, and cars) than do Whites with
similar incomes.This observation is consistent with a simple consumption model where the
demand for conspicuous goods is a function of group income.Heffetz (2011) uses a signaling-
by-consuming motive to derive and test differential predictions regarding income elasticitie
of visible and non-visible goods.
In this paper, the focus is instead on the second group of people.Traditionally, economists
have analyzed the effects ofconsumption externalities based on revealed preferences,i.e.,
by studying changes in behavior.For example,as shown above,an increase in comparison
consumption can affect the marginal rate of substitution between consumption of conspicu
and non-conspicuous goods,thereby changing observed choices.Specifically,an increase in
reference consumption can lead to an outward shift in labor supply and an increase in own
consumption,an effect known as “Keeping up with the Joneses” (Frank,1999). A well
known study along this line is Neumark and Postlewaite (1998) who show that a woman’s
employment probability increases ifthe sister’s husband’s income is greater than the own
husband’s income.More recently, Kuhn et al.(2011) show that living next to a winner in the
Dutch Postcode Lottery increases the level of own car consumption.Even if an externality
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leaves the marginalrate ofsubstitution between conspicuous and non-conspicuous goods
unchanged,other margins can be affected,for example,those related to residentialchoice.
Since conspicuous consumption can be interpreted as a negative neighborhood attribute ¯c,
its effect on U can, in principle, be determined using location decisions (or backed out from
housing prices using a hedonic regression).
An alternative to the revealed preference approach is the stated preference method.Stated
preferences,as elicited in discrete choice experiments (DCE),rely on hypotheticalchoices.
The key advantage of DCEs over revealed preference studies is that it gives the researcher
full freedom and controlin manipulating relative positions.In particular,it is possible to
include the consumption level of others into the choice set (thereby effectively internalizing
it). An example ofthis approach is the “paralleluniverse” question,where one has to
choose between two fictitious societies,for example one,society A,where everyone lives in
a house with 3,000 square feet offloor space,and another one,society B,where the own
house has 4,000 square feet while neighbors have 5,000 square feet.Frank (1999,2004)
contents that most people prefer society A.Solnick and Hemenway (1998) have conducted
more elaborate discrete choice experiments with realpopulations.Interestingly,they find
that leisure appears to be inconspicuous – perhaps in part because it is not so easily observ
by others.
The stated preference and the revealed preference approaches both have their weaknes
The validity of discrete choice experiments critically hinges upon people’s cognitive ability
in valuing hypotheticalalternatives as wellas on their truthfulness in responding to such
questions.DCEs generate hypothetical choice situations, which may be very far from respon-
dent’s actualexperiences,and people may decide differently when faced with realchoices.
The revealed preference approach makes strong assumptions regarding the rationality of
agents and the functioning of markets.For example, it is well possible that individuals are
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not aware of all relevant neighborhood attributes when they make their location decision.For
long-term residents, transaction costs may prohibit a relocation in the presence of negative
consumption externalities, as long as these costs are sufficiently large.
Given the limitations ofthe stated and revealed preference approaches,I propose to
directly estimate the effect of conspicuous consumption on utility,by using stated life- and
income satisfaction as a proxy for utility.Recent evidence suggests that satisfaction can
be measured with a reasonable degree of reliability,sufficient to be able to compare means
over time or across regions, or to use multiple regression analysis to understand the factors
that affect individual satisfaction (Krueger and Schkade, 2008).Moreover, satisfaction taps
into key components ofquality oflife. For example,many studies have found a positive
correlation between satisfaction, or happiness, and longevity.One of the mechanisms seems
to be that satisfaction protects the healthy from becoming sick,by lowering stress,which
in turn enhances the immune system (Veenhoven,2008). Studies have also shown that
individuals who report higher levels of satisfaction with their lives are rated as happier by
their relatives and friends,tend to smile more during socialinteractions,have higher pre-
frontalbrain activity (the part of the brain associated with positive states),and are more
likely to recall positive life events (Layard, 2005).
There is a sizeable literature on the effect of relative income on satisfaction.Studies using
survey data (e.g.,Clark and Oswald,1996,Luttmer,2005,and Dynan and Ravina,2007)
usually find large negative effects of increased reference incomes ceteris paribus, holding o
income constant.This evidence provides an explanation of the so called Easterlin paradox
(Easterlin,1974) whereby large increases in GDP over time have apparently not led to
correspondingly large increases in average satisfaction.
While relative income effects may be related to conspicuous consumption, the connectio
between the two is not obvious.Unfortunately,direct evidence on the effect ofrelative
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consumption on satisfaction is much more sparse, perhaps due to the absence of appropria
data sets.A notable exception is Hsee et al.(2008) who report on evidence from data
collected in 31 large cities in China.Participants were asked about their jewelry possessions
and their satisfaction with it.The researchers found that residents ofcities with more
expensive jewelry were not any happier on average about their jewelry than residents of ci
with less expensive jewelry (although within each city,people who owned more expensive
jewelry reported greater satisfaction with their jewelry).
Hsee et al. (2008) note that while some consumption experiences (such as ambient
temperature, having social company etc.) are inherently evaluable and often have a natura
scale,others (the size of a diamond,the horsepower of a car) are not,and hence are much
more prone to socialcomparisons.Of course,comparison effects can also relate to past
own consumption.There is evidence that hedonic adaptation plays a major role in some
consumption activities, such as the size of a house or apartment, but not in others, such as
the duration of a commute (Stutzer and Frey,2008).One factor contributing to the speed
of adaptation is uncertainty:unstable or uncertain consumption experiences create longer
lasting happiness than their stable and certain equivalents (Kahneman and Thaler, 1991).
3 Data
The empiricalanalysis of this paper combines data from a number of sources:information
on individual satisfaction and household income is obtained from the Swiss Household Pane
(SHP); car registration data, aggregated to the municipal and cantonal level, were provided
by the FederalRoads Office;and information on average incomes and income inequality,
again for each municipality and canton,originate from the Swiss FederalTax Administra-
tion. Unfortunately,the years for which the data are available do not exactly match.Car
9

registrations are available for the years 2001 and 2007,whereas income inequality data are
available for the years 2003 and 2006.The mismatch is kept at a minimum (plus or mi-
nus one year) by choosing 2002 and 2007 as base years and extracting the corresponding
person-year observations from the SHP.
The SHP is comparable in structure and scope to other European panel household sur-
veys,such as the German Socio-Economic Panelor the British Household Panel,now Un-
derstanding Society.It was started in 1999 and is ongoing at annualfrequency (Budowski
et al., 2001).Importantly, the Swiss Household Panel collects information on the following
question:In general,how satisfied are you with your life if0 means “not at allsatisfied”
and 10 means “completely satisfied”? In addition,there are questions on satisfaction with
a number oflife domains,including satisfaction with income.The SHP also provides in-
formation on many of the control variables typically used in satisfaction regressions.These
include household income, household size, age, marital status, employment status, and gen
der.Depending on year, there are between 4000 and 5000 person observations with compl
information on the relevant variables.
An innovation of this paper is the augmentation of the SHP data with regional informa-
tion on cars,mean incomes and income inequality.Two levels of regionalaggregation are
considered, the municipality and the canton.Switzerland is composed of about 2,900 munic-
ipalities.According to the population census of 2000, they range in size from 24 inhabitants
(Corippo in the Verzasca Vally in Ticino) to 368,875 inhabitants (Zurich).A total of 1,053
municipalities are represented among participants ofthe Swiss Household Panel.Switzer-
land is a confederation of 26 cantons whose role and political functions closely resemble th
of the States within the U.S.; Again, population sizes vary considerably, from a mere 15,199
10