Behavioral Economics in China

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Table of Contents

Introduction
Behavioral Economics Theories
The Chinese Luxury Goods Market
Luxury Goods Consumption
Conclusion
Works Cited

Introduction

Behavioral economics can be defined as the study of the effects of psychological, cultural, emotional, and cognitive factors in the process of making economic decisions involving individuals and organizations. The study is characterized by three main aspects: heuristics, market inefficiencies, and framing. Fields of study that interact with behavioral economics include neuroscience, psychology, and microeconomic theory.

Researchers study how individuals make important economic decisions and the motivations behind those choices. Behavioral economics differs significantly from traditional economic theory whose main assumption is that people are perfectly rational and make decisions based on what maximizes their happiness. On the contrary, behavioral economists develop theories that incorporate certain psychological concepts that include procrastination, impatience, wrong decision-making, as well as avoidance of pain and loss. These concepts have allowed economists to fully comprehend how people make decisions that affect their financial welfare.

Behavioral Economics Theories

Bounded Rationality

This theory explores the idea that individual decision-making is influenced by three main aspects: the time available to choose, individual cognitive limitations, and the amount of information possessed. According to the theory, people make rational decisions, whose quality is limited by their cognitive capabilities and the amount of information they can access (Ogaki and Tanaka 71). In that regard, people make choices that satisfy their needs and wants rather than those that offer maximum happiness.

The theory suggests that people do not fully consider every choice or possibility available to them and that could optimize their happiness (Zamir and Teichman 43). The theory argues that people cannot make good and consistent decisions that have positive outcomes. Individuals make decisions that are influenced by factors such as peer pressure, cultural norms, ethics, religious beliefs, and love (Zamir and Teichman 44). Decisions are made through a complex and variable decision-making process that utilizes limited information.

The Prospect Theory

This theory was developed by Daniel Kahneman and Amos Tversky, who developed a framework to explain how human perception of gain and loss influences decision-making on matters related to economics (Zamir and Teichman 49). They referred to the human perception of gain and loss as framing. The two economists argued that decisions are context-dependent and the framing of problems determines a person’s readiness to take risks in making choices.

The decision made is primarily influenced by an individual’s framing of the choice as either a gain or a loss (Zamir and Teichman 50). People dislike losing and like winning. Therefore, in instances where a gain and a loss are equivalent, many people tend to choose the option that is pleasurable to avoid the pain of losing.

Mental Accounting

This theory was developed by Richard Thaler. It argues that in making decisions, people perceive value as a relative rather than an absolute concept (Ogaki and Tanaka 74). For example, people derive pleasure from both the value of a product and the usefulness of the transaction. Moreover, the theory states that people disregard opportunity costs when making decisions, and as a result, succumb to sunk cost fallacy.

The Chinese Luxury Goods Market

The Chinese luxury market is one of the largest in the world. China is a conservative country: it holds on to its cultural practices and implements policies to preserve its traditions (Smith). A few years ago, the government was concerned that consumers were spending a lot on luxury goods. Therefore, it imposed a ban on television and radio advertisements for luxury goods. The move was aimed at mitigating the effects of the widening gap between the rich and the poor.

Also, the government was concerned that these advertisements hurt Chinese cultural values. The ban was imposed at a time when the Chinese were ranked as the top luxury shoppers in the world. They had overtaken the Japanese, who were the top luxury shoppers in 2012. Projections indicate that the luxury goods market will continue to grow through 2020.

Projected growth of China’s luxury-goods market — *Fig 1: projected growth of China’s luxury-goods market (Bu et al.).*

The increase in the number of Chinese luxury shoppers was associated with the country’s rapid economic growth in the past two decades. Moreover, the country has a high population with a rising percentage of affluent consumers. According to a report released by McKinsey in 2017, the firm revealed that Chinese shoppers spend approximately $71.9 billion every year on luxury goods (Smith). This amount accounts for about 30 percent of the world’s luxury goods market.

This percentage is projected to rise to 40 percent by the year 2024, regardless of the Chinese economy slowdown (Smith). Chinese consumers spend a lot of money on international brands such as Gucci, Versace, and Prada. However, they are beginning to embrace domestic brands, and the demand for international brands might dwindle in the future. Domestic designers are gaining acceptance because their designs reflect the pride that the Chinese have in their culture.

The most common luxury goods in China include fragrances, cosmetics, handbags, jewelry, automobiles, electronics, and fashion. The Chinese market is dominated by store-based retail, with the top ten luxury brands operating outlets in the country (Smith). They are mainly located in economically developed regions and cities. For example, Louis Vuitton entered the Chinese market in 1992, and by the year 2015, it had expanded its presence to 44 stores across the country (Smith). The market is large because consumers buy products from stores and online vendors. In China, owning a luxury car is a symbol of wealth and sophistication. Luxury car brands such as BMW, Aston Martin, Jaguar, Lamborghini, and Land Rover are competing fiercely as the car luxury market undergoes rapid expansion.

Statistics show that the market for luxury goods in China is projected to expand in the coming years. By the end of 2018, China is expected to have the largest number of millionaires in the world. Moreover, by 2021, China is expected to have the richest households that will possess the financial power to purchase luxury goods. It is estimated that 7.6 million households spend an average of RMB 71,000 every year on luxury goods (Smith).

This amount is larger than the average spending in other developed countries such as Italy and France. The luxury goods market has grown tremendously. For example, in 2008, China accounted for approximately 12 percent of the global market (Smith). However, a decade later, about 75 percent of the luxury goods market growth has been attributed to spending by Chinese shoppers. Government statistics show that luxury shoppers increased by 50 percent between 2008 and 2014 (Smith). This increase has been attributed to higher earnings and the increased presence of luxury goods in the country. According to McKinsey & Company, more than 1 trillion RMB will be spent on luxury goods by Chinese shoppers.

Luxury Goods Consumption

Cultural values are one of the main factors that influence the purchasing decisions of Chinese. This explains why domestic and foreign-based designers are gradually gaining acceptance in China. Confucian ideals play a key role in influencing the majority of the decisions made by consumers. In that regard, individual needs are more important than a group’s welfare. Researchers have shown that the main motivation behind the purchasing behaviors of Chinese shoppers is the comprehensive value of the brands they purchase (Smith). In that regard, positional value consumption is the hallmark of the Chinese luxury goods market.

According to the mental accounting theory, people have different perspectives regarding money depending on how they plan to use it and how the money was earned (Wilkinson and Klaes 77). Chinese luxury shoppers can be divided into three groups based on their attitudes towards luxury goods. The first group perceives luxury as a functional concept. In that regard, people belonging to this group conduct extensive research through surveys to find the most valuable goods to purchase.

Their purchasing decisions are based on rational analysis (Wilkinson and Klaes 77). Emotion plays an insignificant role in their purchasing behaviors. The second group perceives luxury goods as a form of reward. In their minds, purchasing luxury goods is a way of showing others their level of success. People in this group buy luxury cars, jewelry, and expensive houses. Their purchases are usually irrational. The third group views the purchase of luxury goods as a way of indulging their tastes. As a result, they engage in conspicuous consumption because they have money to spend (Wilkinson and Klaes 78). Their decisions are based on emotions, and they are highly susceptible to impulse buying.

One of the main overarching aspects of consumer purchasing behavior is conformity. Consumer conformity behavior refers to the tendency of individuals to purchase certain goods and services because of the influence of their friends, relatives, or family members (Wilkinson and Klaes 64). This phenomenon originates from reference groups or group norms. Peer pressure is one of the major causes of consumer conformity behavior.

This trend is common in China. Luxury is considered elitist in many areas, and consumers acquire luxury goods to fit in this group (Smith). In that regard, purchasing decisions are based on the need to maintain one’s social identity. People who identify themselves as rich will buy luxury goods to demonstrate their wealth, even though the purchases are unnecessary. For example, a consumer will buy a Louis Vuitton shoe to reinforce their social identity as a millionaire and distance themselves from the middle-class group. Many Chinese shoppers use luxury goods as tools for reinforcing their social distinctiveness.

As mentioned earlier, China is a culturally oriented society. Therefore, purchasing decisions are influenced by factors such as reciprocity, face-saving, and relationship. In China, gift-giving is an important cultural component. People give gifts to friends, family members, and business associates. The cultural value that is ascribed to gifts in China plays a significant role in influencing the purchase of luxury goods (Smith).

Social referents, which are determined by affiliation and cultural background influence people into making decisions that are based on cultural norms. People will buy expensive gifts for family members or business associates because of their relationship and the cultural importance of gift-giving. A study conducted by a research company known as Millward Brown revealed that Chinese consumers perceive shopping as an enjoyable activity rather than a chore (Bu et al.). Therefore, they derive more pleasure from shopping than consumers in countries such as the United Kingdom and the United States.

According to bounded rationality, one of the factors that affect the decisions that people make is the information they possess (Ogaki and Tanaka 57). Inadequate information is one of the concepts that can be used to explain the rapidly growing luxury goods market in China. The majority of the people in the middle class rely on information from fashion experts, friends, and social media to make decisions regarding the goods they purchase.

Shoppers make decisions after reading product reviews on social networking platforms and other online forums (Bu et al.). Research has shown that the Chinese are more likely to post feedback on their shopping experiences when compared to Americans. This explains why social media has been cited as the best strategy to sell luxury brands in China. The decisions of these consumers are based on the brand perceptions of other people (Bu et al.). Therefore, they may make the wrong decisions because people’s views regarding certain products and services may be biased.

The majority of Chinese shoppers perceive luxury as an indulgence. Therefore, they buy goods to show off and fit in into specific social groups. The middle-class value possessions highly and spend a large percentage of their earnings on expensive items. Elite groups buy products for self-actualization and social comparison reasons (Bu et al.). Therefore, their purchase decisions are based on social preference, which is one of the aspects studied in behavioral economics.

Conformity among consumers is common as people seek to reinforce their social status. This is one of the reasons why the luxury market is rapidly growing in China (Bu et al.). Consumers are making decisions based on peer pressure and group norms. People who consider themselves as elite buy luxury goods too, although they prefer unique and rare products.

According to the mental accounting theory, people relatively perceive the value of things. In decision-making, value is not an absolute, but a concept that varies depending on individual perceptions (Wilkinson and Klaes 68).

In that regard, people find pleasure in the value of a product as well as the quality of the transaction. The theory also postulates that people disregard opportunity costs when making decisions. This tendency increases their susceptibility to the sunk cost fallacy. Chinese shoppers are highly susceptible to conformity because of the country’s cultural orientation. They do not consider cost-effective alternatives to their purchases.

Conclusion

Theories of behavioral economics can be used to explain the current state of the Chinese luxury markets. Over the past decade, the number of luxury goods consumers has increased significantly. Behavioral economics theories such as bounded rationality, mental accounting, as well as prospect theory explain why and how people make economic decisions. Bounded rationality argues that people make decisions that are limited by the information they possess, cognitive weaknesses, and the time available. Prospect theory states that people make decisions based on their perception of gain and loss.

Mental accounting argues that people treat money and the concept of value differently. These theories are effective in explaining why people make certain economic decisions. Chinese consumers buy luxury goods based on social preferences, cultural practices, peer pressure, group norms, and the unavailability of adequate information.

Works Cited

Bu, Lambert, Durand-Servoingt, Benjamin, Kim, Aimee, and Naomi Yamakawa. “Chinese Luxury consumers: More Global, More Demanding, Still Spending.” McKinsey & Company. Web.

Ogaki, Masao and Saori Tanaka. Behavioral Economics: Toward a New Economics by Integration with Traditional Economics. Springer, 2017.

Smith, Tamsin. BCG: China to Drive 70 Percent of Global Luxury Growth by 2024. Jing Daily. Web.

Wilkinson, Nick and Matthias Klaes. An Introduction to Behavioral Economics. 3rd ed., Palgrave Macmillan, 2018.

Zamir, Eyal and Doron Teichman, editors. The Oxford handbook of Behavioral Economics and the Law. Oxford University Press, 2014.

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