Academic journal article Economic Inquiry

Pricing Anomalies in the Market for Diamonds: Evidence of Conformist Behavior

Academic journal article Economic Inquiry

Pricing Anomalies in the Market for Diamonds: Evidence of Conformist Behavior

Article excerpt

I. INTRODUCTION

Diamonds have long intrigued economists. Adam Smith and the classical economists asked why diamonds, which have so little value in use, have such high value in exchange. It took another century before Jevons and the marginalists offered a satisfactory resolution. (1) Diamonds are not the typical economic good. In industrial processes requiring drilling or grinding, their hardness makes them a valuable input. But, in their other primary use, jewelry, consumption decisions have two dimensions.

Consumers demand diamonds for the intrinsic utility that comes from wearing pretty things. As Becker, Murphy, and Werning (2005) point out, however, "a subset of goods, such as diamonds and gold, may implicitly provide a market for social status, perhaps by the relative amounts consumed of these goods." Ng (1987) introduces the term "diamond effect" to refer to goods like diamonds that are valued not for their intrinsic consumption effects but because they are costly. Bagwell and Bernheim (1996) suggest that because expensive jewelry is readily observable, it provides a "durable emblem of substantial resource dissipation." Glazer and Konrad (1996) offer diamond rings as a prime example of conspicuous consumption intended as a signal of status.

There are several aspects of the market for gem-quality diamonds that make it interesting to study. First, nature introduces exogeneity on the supply side that determines the characteristics of diamonds offered for sale. Second, while diamonds rank high on the visibility scale, (2) the exact attributes of a diamond ring are only imperfectly observable to other people, and so to a certain degree, they must rely on information provided by the ring's owner. Third, a primary source of the demand for diamonds is for engagement rings. In the early days of the industry, Cecil Rhodes connected the number of diamonds supplied annually to European consumers by De Beers to the number of wedding engagements. (3) As a result, diamonds purchased for engagement rings represent in some sense the posting of a bond in the formation of a long-term relationship. (4)

While customers have traditionally purchased diamonds by visiting jewelry stores and other bricks-and-mortar locations, a thriving online market for diamonds has recently developed. Online sellers like Blue Nile, Union, and Amazon sell individual diamonds as well as diamond jewelry. Each has tens of thousands of diamonds in inventory, which they offer for sale on their Web sites. We have collected data from each of these diamond retailers and use these data to analyze empirically the determinants of diamond prices. We find significant jumps in prices at round number sizes or "focal points." For example, we find that buyers are willing to pay premiums upward of 18% for a diamond that is one-half carat rather than slightly smaller than one-half carat and between 5% and 10% for a one-carat diamond rather than a slightly less than one-carat diamond.

Such an anomalous market outcome for a good that already has been singled out by economists as being different begs closer scrutiny. In the next section of the article, we explore in more detail the market for diamonds and describe the data that we have collected from online diamond retailers. Following that, we analyze empirically the various attributes of diamonds that determine their prices, which allows us to identify pricing discontinuities that occur at focal point sizes. We then explore several alternative explanations for the observed pricing anomalies, including whole-number effects, rule-of-thumb purchasing decision rules, diamonds as a store of value, and status good/posting bond reasons. We conclude that the diamond market exemplifies conformist behavior, wherein prospective grooms influence their fiancee's perception of them as a marital prospect through the size of the engagement ring they purchase.

II. THE MARKET FOR DIAMONDS

A. …

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