“Even economics is based on the notion of “revealed preferences.” What people “think” is not relevant—you want to avoid entering the mushy-soft and self-looping discipline of psychology. People’s “explanations” for what they do are just words, stories they tell themselves, not the business of proper science. What they do, on the other hand, is tangible and measurable and that’s what we should focus on. This axiom, perhaps even principle, is very powerful but is not followed too much by researchers. Revelation of preferences is best understood by the betrothed: a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”
Skin in the Game, (A Brief Tour of Symmetry, Prologue, Part 2) by Nicholas Nassim Taleb
Before we move on to today’s topic, here’s some advice for you if you are just beginning your study of economics. Read as many books as you can lay your hands on by Taleb, and ask yourself why he disses economics so. You don’t have to agree with him – that is up to you – but you should try and understand where he’s coming from.
But now on to today’s topic.
Say you’ve finished learning a bit about economics, and you think you’re beginning to “get it”. Incentives matter, trade matters, prices matter yada-yada-yada. We get it. Demand curves slope downwards, and actually, if you think about it, economics is simple.
Yes?
Well, then answer me this: if the price of diamonds goes down, will demand for engagement rings increase, or decrease?
Take your time, there’s no hurry.
As I’m fond of saying in my classes, “whatever your answer, please also tell me why it is whatever it is”.
So – if you’ve learnt well, you should have predicted that demand will go up. The lower the price, the higher the demand will be!
Except, as it turns out, the world ain’t quite so simple. In the case of engagement rings, a reduction in the price of diamonds will lower the demand for ’em.
Why?
Because as both Imperial Blue and Taleb tell us, “a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”
That is, the point of buying the ring is to show to your betrothed that you have skin in the game. If it is cheap, it don’t count. How do you show your commitment to the relationship? By putting down an eye-wateringly large amount of money to buy a ring. If the eyes don’t water, it don’t count.
You will learn about value-in-use and value-in-exchange sooner or later as a student of economics. Turns out there is also value in signaling. And the value in signaling comes from how expensive the good is, in the case of the diamond ring.
De Beers started selling its own lab-grown diamonds in 2018 at a steep discount to the going price, in an attempt to differentiate between the two categories. The company expects lab-grown prices to continue to tumble, in what it sees as a tsunami of more supply coming on to the market, Rowley said. That should create an even bigger delta in prices between natural diamonds and lab grown, helping differentiate the two products, he said.
https://marginalrevolution.com/marginalrevolution/2023/09/a-diamond-pricing-puzzle.html
Please read the whole post, as always. But if lab-grown diamonds are indistinguishable from, well, natural diamonds, they ought to be substitutes. And if they are substitutes, a reduction in the price of one good ought to lead to a reduction in the price of its substitute. If Coca-Cola is made cheaper, Pepsi has very little choice but to follow.
Then how do we explain a company like De Beers deliberately reducing the price of a substitute? Not just reducing it! They’re saying that the reduction in the price is what helps differentiate the products!
This is a nuanced point, and worth a deeper explanation.
De Beers accepts and acknowledges that lab grown diamonds are substitutes for natural diamonds. It accepts that there is bound to be a reduction in the price of lab-grown diamonds because of the “tsunami” of the increase in supply of lab-grown diamonds.
So how do they try and ensure that the demand for natural diamonds stays the same? By reducing the price of lab-grown diamonds even more than the market price. Demand for natural diamond goes up, the cheaper the lab grown diamonds are. De Beers is simply hastening that process.
As I’m fond of saying, you should always ask a simple question: what are you optimizing for?
And in the case of diamond rings, you ain’t optimizing for saving money. You’re optimizing, in fact, for spending money.
Signaling matters!
And speaking of skin in the game, if you can’t afford a diamond ring, what might make for an acceptable substitute…?
EconForEverybody 