Why I need an iPhone 4

iPhones have taken the mobile phone industry by surprise by becoming an increasingly popular device. What are the reasons, by applying a neoclassical economic approach, for individuals to purchase Apples newest product, the iPhone 4?

Firstly I will look into the wider context of neoclassical economics and how its role is important throughout the entire purchasing process. This theme is followed throughout the paper, as it is important to note that it is in the foreground of my research. Secondly I will explore conspicuous consumption. As this is, again, another major topic for my research, I will be concentrating on this throughout. Thirdly I will look into methodological individualism and collectivism, as these are important in determining the use of neoclassical economics in today’s society. I will then look into rationality and bounded rationality, and see what the difference between the two mean, while looking at neoclassical economic theory. Finally these are all linked in with my own ideas and a conclucion.

 

Years ago a person, he was unhappy, didn’t know what to do with himself – he’d go to church, start a revolution – something. Today you’re unhappy? Can’t figure it out? What is the salvation? Go shopping.

The Price, Act 1 (cited in Stebbins 2009, 82)

Neoclassical Economics

For years there have been millions of iPhones unequally distributed to people around the globe. But how many of these consumers are rational? How many of these tech-savvy individuals truly and wholeheartedly made an informed choice into what phone suits them and their needs? The answer may lie in how effective rational, informed and intuitive agents are. By looking at the most popular approach to economics, neoclassical economics, I will look into why neoclassical economics fails to describe why people are not rational and are infatuated in conspicuous consumption. There are many theories to neoclassical economics; therefore I will explore a few of the most interesting topics. So by applying its own theories into use, I will explain why I need an iPhone 4.

The most popular and currently the most demanded form of economic theory is the neoclassical approach to economics. Thorstein Veblen has been identified as the person who attached ‘neoclassical’ to the study of economics (O'Hara 1999, 210). By no means is this a homogenous form of economics. There are many different variations, each with different theories in their own rights. My research will focus on the neoclassical approach only. The Neoclassic approach of economics can be traced back to Adam Smith. Neoclassical economics has focused on Smiths idea of self-interest, especially since his book titled An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776:

It is not from the benevolence of the butchers, the brewer, or the bakers that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Adam Smith

Firstly I will look at conspicuous consumption and emulation. O'Hara (1999, 137-138) describes both of these, with conspicuous consumption as a direct process to impress others in order to avoid condemnation. This is a feature of emulation which is displaying goods and services which were purchased at a higher than average price. These are explored throughout, with a focus on how neoclassical economics does not explain why people are never completely satisfied with what they can easily and happily afford.

Methodological individualism and collectivism are two neoclassical ways of describing how agents demand goods and services. Both focus on the reasons how individuals consume, and how groups consume. Hauswirth (2006, 27) expresses how methodological individualism is the assumption about human nature.

In neoclassical economics, it focuses on individuals as consumers who are fully rational with the ability to maximize their utility. There are three theories to the neoclassical approach according to Samuel Bowles (2004, 9), rationality, greed and equilibrium. I will concentrate on rationality throughout my research, as it gives the most appropriate answer for the question of how neoclassical economics has flaws.

These topics will each be explored and with a neoclassical economic theory in each of them. The theories will be explained and then looked at from another prospective.

Conspicuous consumption and emulation

Lavish spending on goods to acquire a certain social perception from others is something many of us are all too familiar with. Conspicuous consumption is defined as the process itself to try and impress others, which is drawn by emulation, which is the attempt to gain prestige in the eyes of others by displaying a higher ability than average to pay (O'Hara 1999, 137-138). But we should not know anything of the sort according to neoclassical economics. This would be branded as irrational, so why do we do it?

Well remember your neighbour who got that fancy new car, or that colleague who told you about their holiday to Hawaii, or maybe when your friend explained why they purchased a beach house just for the weekend?

As humans, sadly enough we are irrational. Some of our consumption tends to be in order to obtain some amount of gratification or to avoid some other amount of deprivation (O'Hara 1999, 137).  So that car your neighbour purchased for the family was not for its new reversing camera, airbags and fuel efficient engine, it was for the sunroof, leather seats and how everyone else along the street perceives them. O’Hara (1999, 138) describes how conspicuous consumption itself includes jumping on the bandwagon and the snob effects in consumers. Both are self-explanatory concepts, so I will use a real case to describe this theory.

I have a friend; we will call him Alex in this case. Alex wished to purchase a car and I offered to help him search for one. The mission was going to be nearly impossible, a post year 2000 vehicle with 4 doors and under $5,000. There should have been alarm bells from that point in time; no one could ever find such a car. After several weeks I had a knock at the door and sure enough, Alex found what he wanted. It was his first car, so it was never going to be anything flash or up market, so I never expected too much. As I walked outside I saw a car worth five times what he initially wanted to spend. After congratulating him, I asked why and how he got the car.
‘Well you know I don’t like anything second hand,’ was his response.
I did not know that until then. And as for how, well the money was borrowed from the bank.

So now we will analyze that. The car was outside of Alex’s price range, so he borrowed the money. The car was not exactly what Alex first had in mind. The car probably was not even needed as Alex works on public transport and has all his travel expenses paid for. So simply it boils down to one thing, conspicuous consumption. Alex attempted to obtain prestige by displaying his own ability to pay five times more than what he could afford.  And yes, Alex does have an iPhone for the record, which also plugs into his speaker system in the car.

The bandwagon effect is simple, is it a current movement that attracts wide support. The snob effect can be defined as people who see others as inherently inferior to themselves. One would suspect that this has many striking similarities into peoples’ purchasing habits. Why do people shop at discount department stores but why do people also go to exclusive retailers? Stebbins (2009, 83) describes shopping may be forced by circumstances, but the shopper decides within the constraints of when, where, how and perhaps, who to buy the needed goods and services for. Chances are if shoppers purchase a gift, they will typically spend more on that gift than they would have on themselves. By purchasing a gift which is outside of one’s price range, it unfortunately is known as conspicuous consumption. It expresses ones desire to gain satisfaction, either personally or from gratitude from the person receiving the gift.

When one emulates, they have a desire to show off what it is that makes them differ to another person. It might sometimes be enough to aggravate people, as it is colloquially known as bragging. Stillwell (2006) describes how poorer people try to use emulate the rich and famous. They do so by purchasing scaled-down and cheaper versions of goods and services according to their limits and incomes, but it is a process fought with inherit frustration. So no wonder you cannot stand listening to your neighbours car driving past, your collegues trip to Hawaii or your friends beach house. Stillwell understands why you are frustrated.

Methodological Individualism and Collectivism

Individual behavior can be traced down to methodological individualism. It is a bottom up approach which looks at how an individual is influenced in their consumption of goods and services. Methodological collectivism on the other hand looks into reasons as to how groups or populations of people influence consumption. In contrast to methodological individualism, methodological collectivism is a top down approach. By looking at how these two approaches in neoclassical economics works, I will highlight some of its own flaws.

Methodological individualism looks at why individual agents consume goods and services. Joseph Schumpeter describes the theory as ‘just means that one starts from the individual in order to describe certain economic relationships’ (cited in Hodgson 2007, 2). Put simply, agents have a pre-determined set of wants, interests, purposes and needs which makes up the whole of what a person demands. The focus is set on individuals, who make up the whole, hence the bottom up approach. Methodological individualism works by breaking down the equilibrium, shown in figure 1, as it does not always work. For example the theory assumes agents will seek out what best satisfies their needs, but fails to incorporate conspicuous consumption into its theory. When there is a flaw in the theory, it could create a series of other issues. Therefore methodological individualism does not fully explain rationality, which is explained further on in this research paper.

Methodological collectivism on the other hand looks at how groups influence individuals. Although it can be argued that this is true in a sense, such as how traditions remain to get passed on to younger generations and how culture plays an important role in the lives of people. What methodological collectivism theory does is argue that collectively groups influence what agents want, their interests, purposes and needs. What methodological collectivism fails to acknowledge is that it is not always the case where knowledge gets passed on from one generation to another. It is known as assumed knowledge, therefore the theory would mean that I would understand what my parents know as I was born with the knowledge. If that were the case, I would have good phone communicating skills and be able to weld metal. Methodological collectivism does not take into consideration what other affects do not always determine what groups could do to influence individuals.

Both methodological individualism and methodological collectivism are flawed theories which fail to acknowledge other variables. They do not take into consideration some aspects, such as what causes a breakdown of the equilibrium curve. It could be said that a mixture of both make up part of what individuals demand, but it does not make up the whole. There are more ideas which can be used to describe why people are never able to make a decision solely. Other theories to describe why people consume goods and services are conspicuous consumption, which was explored previously and rationality which we will look into next.

Rationality and Bounded Rationality

Hands up if you think you are rational? Okay…put your hands down now so you can read this. Sorry but you are most likely not. According to Tisdell (1996, 3), most individuals and groups are less rational than suggested by the traditional economic view of rational behavior and many may even be less rational than suggested by recent conceptions of bounded rationality.

To be rational, it is implied that individuals have perfect knowledge of their possibility sets, have complete transitive preference ordering and also choose their most preferred option (Tisdell 1996, 4). Selten(2001, 14) express their view that to be fully rational it requires unlimited cognitive capabilities. When an agent is described as being bounded rational it means they have limited knowledge, where they settle for satisfactory outcomes rather than requiring optimal ones (Tisdell 1996, 5).

In neoclassical economic theory, the supply and demand curves are both derived by the supply curves of individual sellers and the demand curves of individual buyers. The supply and demand curves are at equilibrium when they cross, but for the figures to be obtained, they assume individuals engage in rational behaviour. This may ultimately result in a flaw in the most basic of graphs in neoclassical economics, seen in figure 1 of the appendix.  Agents must maximize their expected utility in consistency with the utility curves, which is computed from their past observed behaviour. When individuals do not maximize their utility, that is when issues arise with neoclassical economics. When agents are not rational, they may affect the outcome of what firms and economies predict.

What forms individuals ability to be perfectly rational also links back to methodological individualism and collectivism. When a person is thought to be completely rational, they can be thought of as almost removing themselves from being human. No one person is rational in every decision making process. For example, as humans, we find it easier to spend someone else’s money than our own, as the decision making process is almost removed, there certainly is no rationality. But we also find making micro payments, or installments, easier to manage and handle, especially in increasingly uncertain economic times. Services such as lay-by became popular during 2009, when the ‘economic crunch’ hit, with the lay-by market in Australia alone estimated at $2 billion (Sikora 2009).

Most households operate on a cash flow basis, you know, money in, money out. You’ve got to be very, very careful about what you spend. You’ve got to have micro payments in order for you to get the thing that you absolutely desire. They’re just making it easy. (Howcroft 2010)

Maybe, due to micro pay, it might be how mobile phones became so popular. Gone are the days where people were so frugal that even $30 a month per mobile contract would send some families into melt down. With the launch of smart phones several years ago, it removed the need for people to carry diaries, calculators, maps, watches and many everyday items. Could this be why the smart phone revolution took off so well? Well maybe. Adding together the cost of an iPod Touch, seen in appendix 1, it alone costs $378. By upgrading a phone from $30 a month to $49 a month, with more calls included (or so you think), these can quickly outweigh the cost and benefits. Here is a hypothetical situation.

Jane was on $19 a month phone plan, which was soon to expire. She decided to then look into a new phone plan with her current carrier and saw a smart phone for $79 a month. After a bit of persuasion from the sales assistant, she got herself the new iPhone her friends have been raving about. Jane’s addiction to bejeweled became ever increasing, and so did her phone bill. The phone removed the need for her to use her landline, so now she was saving a minimum of $20.95 a month (Telstra 2010). There is still a $39.05 a month extra cost (in nominal terms) associated with Jane’s new phone.

A neoclassical economist would sit down with Jane, look her in the eye and ask why she would spend $937.20 extra over the term of her 24 month contract. Jane, being the stereotypical  generation Y she is, she tells the neoclassical economist firstly it is none of their business, besides, maybe she looks better holding this phone to her face all day.

By making bounded rational choices consumers have, they block out other variables. Jane might not have needed the new phone, but it might make her feel better, boosting her confidence she might have needed. That $39.05 a month extra might be the difference between being judged by her peers as uncool, to being stylish. The costs associated are not always as tangible as economist may think.

What hinders many agents choices may be due to many factors. They range from the cost of collecting data, having limited knowledge and too much choice, that ultimately the agent will choose a satisfactory outcome, rather than an optimal one. Herbert Simon (1961, cited in Tisdell 1996, 5) argued that ‘satisficing’[1] rather than maximizing behaviour portrays human behaviour better and proposed that the concept of economic man be replaced with ‘administrative man’. Selten (2001, 14) goes one step further by describing ‘fully rational man’ as a mythical hero who knows the solutions to all math problems and can perform computations regardless of its difficulty. If every individual were to become rational decision makers to best maximize their utility, then it would see the end of a human trial and error. Every situation would be plagued with what best outcomes could be achieved. What does not help is that there are more and more choices in everything we buy. Not only are food products now coming in new lite and diet varieties, they come with offers, buy three for the price of two and so on. ‘Administration man’ and ‘fully rational man’ would be at Coles picking out the healthiest, cheapest and best value items for hours. As humans, we make bounded rational choices, so what we are used to buying is what we will continue to buy.

There’s an App for that

What are the reasons for people wanting an iPhone? Apple has made its products accessible to many people. Some famous people to own iPods are Queen Elizabeth II, Barack Obama, Pope Benedict XVI and comedian Stephen Fry (McAlpine 2010; The Sun 2010; Choo 2010; Fry 2010). It is no wonder that by having some of the most powerful people in the world with iPods, it gives people a reason to almost copy them.  According to msnbc.com, during 2005 revenue for Apple in one quarter was a record $3.24 billion, up nearly 70 percent from $1.91 billion in the same quarter the previous year (msnbc.com). The success of the current iPhone came from the back of the popular iPod, which Apple keeps riding.

Apples recent iPhone 4 was the companies worst kept secret. Every year during September, they also release new iPods to keep up with trends and a competitive market. When the iPhone was released, there were suddenly many variations of the product, from the HTC, Nokia, Android and Blackberry, they each have characteristics which qualify them to be known as smart phones. They each have different functions, but in general operate the same, such as send/receive phone calls and messages. What makes these phones desirable is in the eye of the beholder. Every mobile service provider in Australia charges different prices for iPhones, when compared to other smart phones. Conspicuous consumption and emulation theory explains that agents demand these products in order to impress others and avoid condemnation by others, so they purchase goods at a higher price to gain prestige.

Methodological individualism and methodological collectivism theories both would say that everyone who wants an iPhone want one because they were hard-wired to want the product or that it is of cultural significance. Obviously this is seen as ridiculous as there are, by no means, ways for individuals to want an item before it is invented. Therefore to use these two theories to describe why anyone would want an iPhone would not be rendered valid. However it is useful to use the theory as it does give an insight into what could be used to predict why people want iPhones. What is not mentioned is that society will often welcome new technologies and embrace the use of them, therefore when another person also has the pleasure of owning the same device, they could feel of connecting with their society. Therefore it methodological individualism and methodological collectivism should not be used to justify why an agent would want an iPhone.

By looking at the price of an iPod and iPhone, they can easily add up to a ridiculous total. There are a huge number of people who own iPods, so the choice to move to the iPhone is a natural progression after Apple has built up a relationship with the consumers. It is far cheaper to replace a broken or outdated iPod with an iPhone as it incorporates both goods in the one product. Looking at table 1 of the appendix, the mean price difference between the products is 145.39%. When compared to the USA, it is only 100.33%. When the Purchasing Power Parity[2] was applied it showed that the iPod Touch[3] is overvalued in every country except for the UK. Therefore this shows that the currency for each country is overvalued except for the UK.  Tilbury (2010) wrote the CommSec iPod index is a modern-day variation of the long-running Big Mac hamburger index compiled by The Economist magazine. These types of data are used by organizations to find the true value and for goods and services.

Therefore is it rational for an Australian to purchase the phone in the UK or not? Maybe not, as other issues may not be considered, such as warranty. It would be rational to look at other options of what is best suited within a certain budget. Administrative man and fully rational man would best choose what would optimize their own utility maximizer. Certainly many agents do choose mobile contracts by sticking to their provider for many years. This restricts the knowledge they have, resulting in a bounded rational choice.

iPhones have been in production for several years now. So when agents decide to contract themselves to deals with these phones, they ultimately choose the phones for pure emulation. What extra functions a phone has, removes what a phone truly is. Gone are the days where mobiles were to send messages, receive a phone call and maybe play the odd game of Snake. It is now all about mobile banking, mobile YouTube, voice calls and apps. I have never owned and will never own an iPhone, not because the price of these devices are ridiculously high, but because there are far too many people who own them.

Conclusion

Throughout my research I have realized that although the usage of mobile phones is ever increasing, it is resulting in a larger quantity if conspicuous consumption. There are more options for phone users, while there is an outstanding phone brand, Apple, which currently holds the present day’s title of most popular mobile phone brand.  Its popularity will eventually have to end, as there are new and more advanced pieces of technology for consumers, or if agents become more rational with their choices.

It is therefore seen that as long as Apple continues to capture the market with its various other products, then there may not be a large decline in its fashionable products. Therefore neoclassical economic theory has not shown us, or explained well enough, why Apple continues to become and ever increasingly profitable brand.

Appendix

Country	32GB iPhone 4	32GB iPod Touch	Price difference
USA	$ 299 ($599[i])	$ 299	$ 0 or 0% ($300 or 100.33%)
Canada	$ 779	$ 319	$ 460 or 144.20%
Australia	$ 999	$ 378	$ 621 or 164.28%
New Zealand	$ 1,299	$ 489	$ 810 or 165.64%
Singapore	$ 1,048	$ 428	$ 620 or 144.86%
Italy	€ 779	€ 309	€ 470 or 152.10%
Mexico	$ 11,499	$ 4,579	$ 6,920 or 151.12%
UK	£ 599	£ 249	£ 350 or 140.56%
			Mean 145.39%

Table 1 (Apple 2010)

Country	Currency conversion from  1 USA dollar (23/09/2010)	PPP
USA	-	-
Canada	$ 1.029	-8.91%
Australia	$ 1.045	-26.54%
New Zealand	$ 1.436	-57.42%
Singapore	$ 1.326	-47.31%
Italy	€ 1,445.18	-99.93%
Mexico	$ 12.633	-99.48%
UK	£ 0.638	88.21%

Table 2 (Apple 2010)

Figure 1

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[1] Satisficing is a term coined by Herbert Simon as sacrificing something in order to be satisfied. It is not making the optimal decision, but what is the most sufficient choice to satisfy.

[2] Purchasing Power Parity is a theory of long-term equilibrium exchange rates based price level of two countries, in this example the USA was compared to each country.

[3] iPod Touch was used in this example as the iPhone 4 has two prices in the USA where I highlight the difference between prices.

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[i] AT&T is the service provider for iPhones in the USA. With a 2 year minimum contract the phone is $299. With the no commitment contract it is $599. For the example given, all figures in brackets are the no commitment contract to highlight the difference between the two. This is because Apples website only offers their phones through AT&T. (Patterson 2010)