The Economics Of Luxury Goods - Utility Based On Exclusivity

We propose a model describing consumer demand for a luxury good, in which

the perceived quality of the good is related to its exclusivity, that in turn depends

on the number of consumers buying it. We use this model to analyze the optimal

production and price setting decisions of a luxury good manufacturer and contrast

them with the decisions that would be made by a social planner. We show that

irrespective of the way social welfare is de…ned, a monopoly producer of the luxury

good may select socially optimal prices and quantity. Thus the incentives of the

monopolist producer and the social planner may to some extent be aligned.

1 Introduction and motivation

The economic literature on luxury goods and conspicuous consumption originates from

the work of Thorstein Veblen [13] and John Rae [11] in the nineteen century. One of

main ideas of their work was that wealthy consumers buy conspicuous goods to show

their social status or provide evidence of their wealth. A recent overview of this work

can be found in, e.g. Trigg [12]. The work of Veblen and Rae spawned a fair body of

research on the economics of luxury or status goods. For instance, the ability of the

luxury good owner to signal the owner’s wealth, e.g. Bagwell and Bernheim [3], or the

issues of optimal taxation of ’diamond’ goods, e.g. Ng [10].

The purpose of the current paper is to study the welfare aspects of the luxury goods

industry by contrasting the production decisions of the social planner and those of a

monopolist producer. We adopt a partial equilibrium approach and consider decision

making of a representative consumer for just one luxury good, disregarding the existence

of ’ordinary’ goods and possible substitution e¤ects between the two. We also assume

that the luxury good is produced by a monopolist, and thus assume away competition

between di¤erent producers of luxury goods.

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