When the goal of luxury purchases is to signal their buyers” incomes – ”conspicuous consumption” – then a monopoly will deliver those signals efficiently. If in contrast competitors sell counterfeit copies at low prices, consumers will have to buy larger quantities or higher qualities to transmit the same signals, which wastes resources.

These are among the conclusions of new research by Professor Michael Mandler, published in the May 2018 issue of the Economic Journal.

According to classical economic analysis, the vast disparity between the retail prices of name-brand luxury goods and their cost of production freezes out a host of potential buyers and is therefore inefficient. When pirates enter a market, consumers on the streets of New York or Hong Kong can buy a knock-off of a Gucci handbag at a fraction of its previous price.

Efficiency would then appear to improve: new buyers gain access to the market and the losses of brand-name producers as pre-existing buyers switch to the pirates are matched by the savings of those buyers. As long as consumers are not tricked into thinking that knock-offs are sturdier than they in fact are, classical economics concludes that the economy as a whole will gain.

Professor Mandler”s research takes this argument apart. The monopoly control that LVMH and other big luxury producers hold over their high-status products serves a useful purpose that previous analysts have missed.

The real goals of the Rolex watch and Gucci bag are not to tell time or carry loose change: they signal to others the wealth of the owners of these trophies. The buyers of the newly available knock-offs have a similar goal, to represent themselves as wealthy. This too is conspicuous consumption.

But once everyone learns that you can buy a Rolex for $20 from a street vendor, it will no longer serve as an effective signal. The rich who are trying to flaunt their wealth will be driven to more expensive products that will cost more to produce.

The luxury market will ultimately reach a new equilibrium where people watchers come to know the true value of the ornaments that the rich and the ”wannabes” are displaying. People then end up signalling the same message they transmitted before the knock-offs entered the scene.

Since the new goods the rich must now use to signal their income are more costly to produce, more resources are drawn into luxury production in the new equilibrium. It would have been better never to have allowed the pirates to copy the Guccis and Rolexes in the first place.

Professor Mandler explores a variety of different mathematical analyses of signalling – some where a signal of a higher income is transmitted by the quantity of luxury purchases, some where it is the quality that matters. These analyses deliver a broadly similar message, that piracy in the end wastes resources while leaving the signals that people send unchanged.

Of particular importance in these analyses is the very issue on which the luxury giants concentrate their lobbying energy: their distinctive logos. The sales of a name-brand handbag needn”t crumble when roughly comparable knock-offs appear – as long as the name-brand bag can still be recognised as unique.

Professor Mandler”s study also introduces tools that can analyse a common criticism of conspicuous consumption: that the gains to the rich from being perceived as rich lead to an offsetting harm to the poor.

To assess this point, he compares pooling (where the rich and poor make the same purchases and signal the same income) with separation (where rich and poor make different purchases). Since people might in the aggregate pay more to pool than to separate, pooling can be more efficient than separation, thus validating the above criticism.

Piracy versus Monopoly in the Market for Conspicuous Consumption” by Michael Mandler. Michael Mandler is at Royal Holloway College, University of London.

Michael Mandler