Wednesday, 15 July 2015

An Economic Bubble



Blogger Ref http://www.p2pfoundation.net/Transfinancial_Economics


An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania or a balloon) is trade in an asset at a price or price range that strongly deviates from the corresponding asset's intrinsic value.[1][2][3] It could also be described as a situation in which asset prices appear to be based on implausible or inconsistent views about the future.[4]
Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, when a sudden drop in prices appears. Such a drop is known as a crash or a bubble burst. Both the boom and the burst phases of the bubble are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price under normal market circumstances. Prices in an economic bubble can fluctuate erratically, and become impossible to predict from supply and demand alone.
While some economists deny that bubbles occur,[5][page needed] the cause of bubbles remains disputed by those who are convinced that asset prices often deviate strongly from intrinsic values. Many explanations have been suggested, and research has recently shown that bubbles may appear even without uncertainty,[6] speculation,[7] or bounded rationality.[8] In such cases, the bubbles may be argued to be rational, where investors at every point fully compensated for the possibility that the bubble might collapse by higher returns. These approaches require that the timing of the bubble collapse can only be forecast probabilistically and the bubble process is often modelled using a Markov switching model.[9][10] It has also been suggested that bubbles might ultimately be caused by processes of price coordination[11] or emerging social norms.[8]


Origin of term[edit]

A card from the South Sea Bubble
The term "bubble", in reference to financial crisis, originated in the 1711–1720 British South Sea Bubble, and originally referred to the companies themselves, and their inflated stock, rather than to the crisis itself. This was one of the earliest modern financial crises; other episodes were referred to as "manias", as in the Dutch tulip mania. The metaphor indicated that the prices of the stock were inflated and fragile – expanded based on nothing but air, and vulnerable to a sudden burst, as in fact occurred.
Some later commentators have extended the metaphor to emphasize the suddenness, suggesting that economic bubbles end "All at once, and nothing first, / Just as bubbles do when they burst,"[12] though theories of financial crises such as debt-deflation and the Financial Instability Hypothesis suggest instead that bubbles burst progressively, with the most vulnerable (most highly-leveraged) assets failing first, and then the collapse spreading throughout the economy.

Impact[edit]

The impact of economic bubbles is debated within and between schools of economic thought; they are not generally considered beneficial, but it's debated how harmful their formation and bursting is.
Within mainstream economics, many believe that bubbles cannot be identified in advance, cannot be prevented from forming, that attempts to "prick" the bubble may cause financial crisis, and that instead authorities should wait for bubbles to burst of their own accord, dealing with the aftermath via monetary policy and fiscal policy.
Within Austrian economics, economic bubbles are generally considered to have a negative impact on the economy because they tend to cause misallocation of resources into non-optimal uses; this forms the basis of Austrian business cycle theory.
Political economist Robert E. Wright argues that bubbles can be identified before the fact with high confidence.[13]
In addition, the crash which usually follows an economic bubble can destroy a large amount of wealth and cause continuing economic malaise; this view is particularly associated with the debt-deflation theory of Irving Fisher, and elaborated within Post-Keynesian economics.
A protracted period of low risk premiums can simply prolong the downturn in asset price deflation as was the case of the Great Depression in the 1930s for much of the world and the 1990s for Japan. Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders.

Effect upon spending[edit]

Another important aspect of economic bubbles is their impact on spending habits. Market participants with overvalued assets tend to spend more because they "feel" richer (the wealth effect). Many observers quote the housing market in the United Kingdom, Australia, New Zealand, Spain and parts of the United States in recent times, as an example of this effect. When the bubble inevitably bursts, those who hold on to these overvalued assets usually experience a feeling of reduced wealth and tend to cut discretionary spending at the same time, hindering economic growth or, worse, exacerbating the economic slowdown.
In an economy with a central bank, the bank may therefore attempt to keep an eye on asset price appreciation and take measures to curb high levels of speculative activity in financial assets.[citation needed] This is usually done by increasing the interest rate (that is, the cost of borrowing money). (Historically, this is not the only approach taken by central banks. It has been argued [14] that they should stay out of it and let the bubble, if it is one, take its course.)

Possible causes[edit]

In the 1970s, excess monetary expansion after the U.S. came off the gold standard (August 1971) created massive commodities bubbles. These bubbles only ended when the U.S. Central Bank (Federal Reserve) finally reined in the excess money, raising federal funds interest rates to over 14%.[citation needed] The commodities bubble popped and prices of oil and gold, for instance, came down to their proper levels. Similarly, low interest rate policies by the U.S. Federal Reserve in the 2001–2004 are believed to have exacerbated housing and commodities bubbles. The housing bubble popped as subprime mortgages began to default at much higher rates than expected, which also coincided with the rising of the fed funds rate.
It has also been variously suggested that bubbles may be rational,[15] intrinsic,[16] and contagious.[17] To date, there is no widely accepted theory to explain their occurrence. Recent computer-generated agency models suggest excessive leverage could be a key factor in causing financial bubbles.[18]
Puzzlingly for some, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants should be able to calculate the intrinsic value of the assets simply by examining the expected stream of dividends.[6] Nevertheless, bubbles have been observed repeatedly in experimental markets, even with participants such as business students, managers, and professional traders. Experimental bubbles have proven robust to a variety of conditions, including short-selling, margin buying, and insider trading.[1]
While there is no clear agreement on what causes bubbles, there is evidence[citation needed] to suggest that they are not caused by bounded rationality or assumptions about the irrationality of others, as assumed by greater fool theory. It has also been shown that bubbles appear even when market participants are well-capable of pricing assets correctly.[8] Further, it has been shown that bubbles appear even when speculation is not possible[7] or when over-confidence is absent.[8]
Economists of the Austrian School believe that market participants´ decisions are blurred by the wrong price signals given by artificially low interest rates or credit expansion, which explains why many of these are "fooled" during an asset bubble (they call this the cluster of errors).

Liquidity[edit]

One possible cause of bubbles is excessive monetary liquidity in the financial system, inducing lax or inappropriate lending standards by the banks, which makes markets vulnerable to volatile asset price inflation caused by short-term, leveraged speculation.[18] For example, Axel A. Weber, the former president of the Deutsche Bundesbank, has argued that "The past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles."[19]
According to the explanation, excessive monetary liquidity (easy credit, large disposable incomes) potentially occurs while fractional reserve banks are implementing expansionary monetary policy (i.e. lowering of interest rates and flushing the financial system with money supply); this explanation may differ in certain details according to economic philosophy. Those who believe the money supply is controlled exogenously by a central bank may attribute an 'expansionary monetary policy' to said bank and (should one exist) a governing body or institution; others who believe that the money supply is created endogenously by the banking sector may attribute such a 'policy' with the behavior of the financial sector itself, and view the state as a passive or reactive factor. This may determine how central or relatively minor/inconsequential policies like fractional reserve banking and the central bank's efforts to raise or lower short-term interest rates are to one's view on the creation, inflation and ultimate implosion of an economic bubble. Explanations focusing on interest rates tend to take on a common form, however: When interest rates are set excessively low, (regardless of the mechanism by which it is accomplished) investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as stocks and real estate. Risky leveraged behavior like speculation and Ponzi schemes can lead to an increasingly fragile economy, and may also be part of what pushes asset prices artificially upward until the bubble pops.
Simply put, economic bubbles often occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals to an unsustainable level. Once the bubble bursts, the fall in prices causes the collapse of unsustainable investment schemes (especially speculative and/or Ponzi investments, but not exclusively so), which leads to a crisis of consumer (and investor) confidence that may result in a financial panic and/or financial crisis; if there is monetary authority like a central bank, it may be forced to take a number of measures in order to soak up the liquidity in the financial system or risk a collapse of its currency. This may involve actions like bailouts of the financial system, but also others that reverse the trend of monetary accommodation, commonly termed forms of 'contractionary monetary policy'.
Some of these measures may include raising interest rates, which tends to make investors become more risk averse and thus avoid leveraged capital because the costs of borrowing may become too expensive; others may include certain countermeasures that may be taken pre-emptively during periods of strong economic growth include having the central monetary authority increase capital reserve requirements and attempting to implement regulation that checks and/or prevents processes leading to over-expansion and excessive leveraging of debt. Ideally, such countermeasures lessen the impact of a downturn by strengthening financial institutions while the economy is strong.
Advocates of perspectives stressing the role of credit money in an economy often refer to (such) bubbles as "credit bubbles," and look at such measures of financial leverage as debt to GDP ratios to identify bubbles. Typically the collapse of any economic bubble results in an economic contraction termed (if less severe) a recession or (if more severe) a depression; what economic policies to follow in reaction to such a contraction is a hotly debated perennial topic of political economy.
The importance of liquidity was derived in a mathematical setting[20] and in an experimental setting[21][22] (see Section "Experimental and mathematical economics").

Social psychology factors[edit]

Greater fool theory[edit]

Main article: Greater fool theory
Popular among laymen but not fully confirmed by empirical research,[7][8] greater fool theory portrays bubbles as driven by the behavior of a perennially optimistic market participants (the fools) who buy overvalued assets in anticipation of selling it to other speculators (the greater fools) at a much higher price. According to this unsupported explanation, the bubbles continue as long as the fools can find greater fools to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price.

Extrapolation[edit]

Extrapolation is projecting historical data into the future on the same basis; if prices have risen at a certain rate in the past, they will continue to rise at that rate forever. The argument is that investors tend to extrapolate past extraordinary returns on investment of certain assets into the future, causing them to overbid those risky assets in order to attempt to continue to capture those same rates of return.
Overbidding on certain assets will at some point result in uneconomic rates of return for investors; only then the asset price deflation will begin. When investors feel that they are no longer well compensated for holding those risky assets, they will start to demand higher rates of return on their investments.

Herding[edit]

Another related explanation used in behavioral finance lies in herd behavior, the fact that investors tend to buy or sell in the direction of the market trend. This is sometimes helped by technical analysis that tries precisely to detect those trends and follow them, which creates a self-fulfilling prophecy.
Investment managers, such as stock mutual fund managers, are compensated and retained in part due to their performance relative to peers. Taking a conservative or contrarian position as a bubble builds results in performance unfavorable to peers. This may cause customers to go elsewhere and can affect the investment manager's own employment or compensation. The typical short-term focus of U.S. equity markets exacerbates the risk for investment managers that do not participate during the building phase of a bubble, particularly one that builds over a longer period of time. In attempting to maximize returns for clients and maintain their employment, they may rationally participate in a bubble they believe to be forming, as the risks of not doing so outweigh the benefits.[23]

Moral hazard[edit]

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. A person's belief that they are responsible for the consequences of their own actions is an essential aspect of rational behavior. An investor must balance the possibility of making a return on their investment with the risk of making a loss – the risk-return relationship. A moral hazard can occur when this relationship is interfered with, often via government policy.
A recent example is the Troubled Asset Relief Program (TARP), signed into law by U.S. President George W. Bush on 3 October 2008 to provide a Government bailout for many financial and non-financial institutions who speculated in high-risk financial instruments during the housing boom condemned by a 2005 story in The Economist titled "The worldwide rise in house prices is the biggest bubble in history".[24] A historical example was intervention by the Dutch Parliament during the great Tulip Mania of 1637.
Other causes of perceived insulation from risk may derive from a given entity's predominance in a market relative to other players, and not from state intervention or market regulation. A firm – or several large firms acting in concert (see cartel, oligopoly and collusion) – with very large holdings and capital reserves could instigate a market bubble by investing heavily in a given asset, creating a relative scarcity which drives up that asset's price. Because of the signaling power of the large firm or group of colluding firms, the firm's smaller competitors will follow suit, similarly investing in the asset due to its price gains.
However, in relation to the party instigating the bubble, these smaller competitors are insufficiently leveraged to withstand a similarly rapid decline in the asset’s price. When the large firm, cartel or de facto collusive body perceives a maximal peak has been reached in the traded asset's price, it can then proceed to rapidly sell or "dump" its holdings of this asset on the market, precipitating a price decline that forces its competitors into insolvency, bankruptcy or foreclosure.
The large firm or cartel – which has intentionally leveraged itself to withstand the price decline it engineered – can then acquire the capital of its failing or devalued competitors at a low price as well as capture a greater market share (e.g., via a merger or acquisition which expands the dominant firm's distribution chain). If the bubble-instigating party is itself a lending institution, it can combine its knowledge of its borrowers’ leveraging positions with publicly available information on their stock holdings, and strategically shield or expose them to default.

Other possible causes[edit]

Some regard bubbles as related to inflation and thus believe that the causes of inflation are also the causes of bubbles. Others take the view that there is a "fundamental value" to an asset, and that bubbles represent a rise over that fundamental value, which must eventually return to that fundamental value. There are chaotic theories of bubbles which assert that bubbles come from particular "critical" states in the market based on the communication of economic factors. Finally, others regard bubbles as necessary consequences of irrationally valuing assets solely based upon their returns in the recent past without resorting to a rigorous analysis based on their underlying "fundamentals".
Net Result of a Bubble: The one true constant with all bubbles is that they create excess demand and production. Once the bubble deflates, which it always does, a contraction or consolidation has to occur to alleviate the excess. Two examples are the dot-com bubble and the current housing bubble. In both cases there were huge consolidations, bankruptcies, and deterioration of asset values.

Experimental and mathematical economics[edit]

Bubbles in financial markets have been studied not only through historical evidence, but also through experiments, mathematical and statistical works. Smith, Suchanek and Williams[6] designed a set of experiments in which an asset that gave a dividend with expected value 24 cents at the end of each of 15 periods (and were subsequently worthless) was traded through a computer network. Classical economics would predict that the asset would start trading near $3.60 (15 times $0.24) and decline by 24 cents each period. They found instead that prices started well below this fundamental value and rose far above the expected return in dividends. The bubble subsequently crashed before the end of the experiment. This laboratory bubble has been repeated hundreds of times in many economics laboratories in the world, with similar results.
The existence of bubbles and crashes in such a simple context was unsettling for the economics community that tried to resolve the paradox on various features of the experiments. To address these issues Porter and Smith[25] and others performed a series of experiments in which short selling, margin trading, professional traders all led to bubbles a fortiori.
Much of the puzzle has been resolved through mathematical modeling and additional experiments. In particular, starting in 1989, Gunduz Caginalp and collaborators[20][26] modeled the trading with two concepts that are generally missing in classical economics and finance. First, they assumed that supply and demand of an asset depended not only on valuation, but on factors such as the price trend. Second, they assumed that the available cash and asset are finite (as they are in the laboratory). This is contrary to the “infinite arbitrage” that is generally assumed to exist, and to eliminate deviations from fundamental value. Utilizing these assumptions together with differential equations, they predicted the following: (a) The bubble would be larger if there was initial undervaluation. Initially, “value-based” traders would buy the undervalued asset creating an uptrend, which would then attract the “momentum” traders and a bubble would be created. (b) When the initial ratio of cash to asset value in a given experiment was increased, they predicted that the bubble would be larger.
An epistemological difference between most microeconomic modeling and these works is that the latter offer an opportunity to test implications of their theory in a quantitative manner. This opens up the possibility of comparison between experiments and world markets.
These predictions were confirmed in experiments[21][22] that showed the importance of “excess cash” (also called liquidity, though this term has other meanings), and trend-based investing in creating bubbles. When price collars were used to keep prices low in the initial time periods, the bubble became larger. In experiments in which L= (total cash)/(total initial value of asset) were doubled, the price at the peak of the bubble nearly doubled. This provided valuable evidence for the argument that “cheap money fuels markets.”
Caginalp's asset flow differential equations provide a link between the laboratory experiments and world market data. Since the parameters can be calibrated with either market, one can compare the lab data with the world market data.
The asset flow equations stipulate that price trend is a factor in the supply and demand for an asset that is a key ingredient in the formation of a bubble. While many studies of market data have shown a rather minimal trend effect, the work of Caginalp and DeSantis[27] on large scale data adjusts for changes in valuation, thereby illuminating a strong role for trend, and providing the empirical justification for the modeling.
The asset flow equations have been used to study the formation of bubbles from a different standpoint in [28] where it was shown that a stable equilibrium could become unstable with the influx of additional cash or the change to a shorter time scale on the part of the momentum investors. Thus a stable equilibrium could be pushed into an unstable one, leading to a trajectory in price that exhibits a large “excursion” from either the initial stable point or the final stable point. This phenomenon on a short time scale may be the explanation for flash crashes.

Examples of bubbles and purported bubbles[edit]

  • Uranium bubble of 2007
  • Rhodium bubble of 2008 (increase from $500/oz to $9000/oz in July 2008, then down to $1000/oz in January 2009)[29]
  • Bitcoin bubble of 2013. (Went from a price of about $1000/BTC in late 2013 to less than $300/BTC in early 2015)
Other goods which have produced bubbles include postage stamps and coin collecting.

Examples of aftermaths of bubbles[edit]

See also[edit]

References[edit]

  1. ^ Jump up to: a b King, Ronald R.; Smith, Vernon L.; Williams, Arlington W. and van Boening, Mark V. (1993). "The Robustness of Bubbles and Crashes in Experimental Stock Markets". In R. H. Day and P. Chen. Nonlinear Dynamics and Evolutionary Economics. New York: Oxford University Press. ISBN 0-19-507859-4. 
  2. Jump up ^ Lahart, Justin (16 May 2008). "Bernanke's Bubble Laboratory, Princeton Protégés of Fed Chief Study the Economics of Manias". The Wall Street Journal. p. A1. 
  3. Jump up ^ Shiller, Robert (23 July 2012). "Bubbles without Markets". Project Syndicate. Retrieved 17 August 2012. A speculative bubble is a social epidemic whose contagion is mediated by price movements. News of price increase enriches the early investors, creating word-of-mouth stories about their successes, which stir envy and interest. The excitement then lures more and more people into the market, which causes prices to increase further, attracting yet more people and fueling 'new era' stories, and so on, in successive feedback loops as the bubble grows. 
  4. Jump up ^ Krugman, Paul (9 May 2013). "Bernanke, Blower of Bubbles?". New York Times. Retrieved 10 May 2013. 
  5. Jump up ^ Garber, Peter (2001). Famous First Bubbles: The Fundamentals of Early Manias. Cambridge, MA: MIT Press. ISBN 0-262-57153-6. 
  6. ^ Jump up to: a b c Smith, Vernon L.; Suchanek, Gerry L.; Williams, Arlington W. (1988). "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets". Econometrica 56 (5): 1119–1151. doi:10.2307/1911361. JSTOR 1911361. 
  7. ^ Jump up to: a b c Lei, Vivian; Noussair, Charles N.; Plott, Charles R. (2001). "Nonspeculative Bubbles in Experimental Asset Markets: Lack of Common Knowledge of Rationality Vs. Actual Irrationality". Econometrica 69 (4): 831. doi:10.1111/1468-0262.00222. 
  8. ^ Jump up to: a b c d e Levine, Sheen S.; Zajac, Edward J. (27 June 2007). "The Institutional Nature of Price Bubbles". SSRN 960178. 
  9. Jump up ^ Brooks, Chris; Katsaris, Apostolos (2005). "A three-regime model of speculative behaviour: modelling the evolution of the S&P 500 composite index". The Economic Journal 115 (505): 767–797. doi:10.1111/j.1468-0297.2005.01019.x. ISSN 1468-0297. 
  10. Jump up ^ Brooks, Chris; Katsaris, Apostolos (2005). "Trading rules from forecasting the collapse of speculative bubbles for the S&P 500 composite index". Journal of Business 78 (5): 2003–2036. doi:10.1086/431450. ISSN nokuh 0740-9168 nokuh Check |issn= value (help). 
  11. Jump up ^ Hommes, Cars; Sonnemans, Joep; Tuinstra, Jan; Velden, Henk van de (2005). "Coordination of Expectations in Asset Pricing Experiments". Review of Financial Studies 18 (3): 955–980. doi:10.1093/rfs/hhi003. 
  12. Jump up ^ Quote from The Deacon's Masterpiece or The One-Hoss Shay, by Oliver Wendell Holmes, Sr.
  13. Jump up ^ Robert E. Wright, Fubarnomics: A Lighthearted, Serious Look at America's Economic Ills (Buffalo, N.Y.: Prometheus, 2010), 51–52.
  14. Jump up ^ http://www.gold-eagle.com/editorials/cscb001.html
  15. Jump up ^ Garber, Peter M. (1990). "Famous First Bubbles". The Journal of Economic Perspectives 4 (2): 35–54. doi:10.1257/jep.4.2.35. 
  16. Jump up ^ Froot, Kenneth A.; Obstfeld, Maurice (1991). "Intrinsic Bubbles: The Case of Stock Prices". American Economic Review 81: 1189–1214. doi:10.3386/w3091. 
  17. Jump up ^ Topol, Richard (1991). "Bubbles and Volatility of Stock Prices: Effect of Mimetic Contagion". The Economic Journal 101 (407): 786–800. doi:10.2307/2233855. JSTOR 2233855. 
  18. ^ Jump up to: a b Buchanan, Mark (19 July 2008). "Why economic theory is out of whack". New Scientist. Retrieved 15 December 2008. 
  19. Jump up ^ Weber Says ECB Has Used Room to Cut Interest Rates
  20. ^ Jump up to: a b Caginalp, G.; Balenovich, D. (1999). "Asset flow and momentum: deterministic and stochastic equations". Philosophical Transactions of the Royal Society A 357 (1758): 2119–2133. doi:10.1098/rsta.1999.0421. 
  21. ^ Jump up to: a b Caginalp, G.; Porter, D.; Smith, V.L. (1998). "Initial cash/asset ratio and asset prices: an experimental study". Proceedings of the National Academy of Sciences 95 (2): 756–761. doi:10.1073/pnas.95.2.756. 
  22. ^ Jump up to: a b Caginalp, G.; Porter, D.; Smith, V.L. (2001). "Financial Bubbles: Excess Cash, Momentum and Incomplete Information". J. Psychology and Financial Markets 2 (2): 80–99. doi:10.1207/S15327760JPFM0202_03. 
  23. Jump up ^ Blodget-The Atlantic-Why Wall St. Always Blows It
  24. Jump up ^ "In come the waves: The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops.". The Economist. 16 June 2005. The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops. 
  25. Jump up ^ Porter, D.; Smith, V. L. (1994). "Stock market bubbles in the laboratory". Applied Mathematical Finance 1 (2): 111–128. doi:10.1080/13504869400000008. 
  26. Jump up ^ Caginalp, G.; Ermentrout, G. B. (1990). "A kinetic thermodynamics approach to the psychology of fluctuations in financial markets". Applied Math Letters 4 (4): 17–19. doi:10.1016/0893-9659(90)90038-D. 
  27. Jump up ^ Caginalp, G.; DeSantis, M. (2011). "Stock Price Dynamics: Nonlinear Trend, Volume, Volatility, Resistance and Money Supply". Quantitative Finance 11 (6): 849–861. doi:10.1080/14697680903220356. 
  28. Jump up ^ Caginalp, G.; DeSantis, M.; Swigon, D. (July 2011). "Are flash crashes caused by instabilities arising from rapid trading?". Wilmott Magazine 11: 46–47. 
  29. Jump up ^ "Historical Rhodium Charts". Kitco. Retrieved 19 February 2010. 

Further reading[edit]

External links[edit]


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Tuesday, 7 July 2015

Planned obsolescence

From Wikipedia, the free encyclopedia/ Blogger Ref http://www.p2pfoundation.net/Transfinancial_Economics

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For the 2011 book, see Planned Obsolescence: Publishing, Technology, and the Future of the Academy.
Planned obsolescence or built-in obsolescence[1] in industrial design is a policy of planning or designing a product with an artificially limited useful life, so it will become obsolete, that is, unfashionable or no longer functional after a certain period of time. [2] The rationale behind the strategy is to generate short-term sales volume by reducing the time between repeat purchases (referred to as "shortening the replacement cycle"), until customers catch on and move to another product platform.
Firms that pursue this strategy believe that the additional sales revenue it creates more than offsets the additional costs of research and development and opportunity costs of existing product line cannibalization. In a competitive industry, this is a risky strategy because when consumers catch on to this, they decide to buy from competitors instead.
Planned obsolescence tends to work best when a producer has at least an oligopoly.[3] Before introducing a planned obsolescence, the producer has to know that the consumer is at least somewhat likely to buy a replacement from them. In these cases of planned obsolescence, there is an information asymmetry between the producer – who knows how long the product was designed to last – and the consumer, who does not. When a market becomes more competitive, product lifespans tend to increase.[citation needed] For example, when Japanese vehicles with longer lifespans entered the American market in the 1960s and 1970s, American carmakers were forced to respond by building more durable products.[4]


History and origins of the phrase[edit]

Further information: Phoebus cartel
In the United States, automotive design reached a turning point in 1924 when the American national automobile market began reaching saturation. To maintain unit sales, General Motors head Alfred P. Sloan Jr. suggested annual model-year design changes to convince car owners that they needed to buy a new replacement each year, an idea borrowed from the bicycle industry, though the concept is often misattributed to Sloan.[5] Critics called his strategy "planned obsolescence". Sloan preferred the term "dynamic obsolescence". This strategy had far-reaching effects on the auto business, the field of product design, and eventually the American economy. The smaller players could not maintain the pace and expense of yearly re-styling. Henry Ford did not like the model-year change because he clung to an engineer's notions of simplicity, economies of scale, and design integrity. GM surpassed Ford's sales in 1931 and became the dominant company in the industry thereafter. The frequent design changes also made it necessary to use a body-on-frame rather than the lighter, but less flexible,[clarification needed] monocoque design used by most European automakers.


Ending the Depression Through Planned Obsolescence, by Bernard London, 1932
Origins of planned obsolescence go back at least as far as 1932 with Bernard London's pamphlet Ending the Depression Through Planned Obsolescence.[6] The essence of London's plan would have the government impose a legal obsolescence on consumer articles, to stimulate and perpetuate consumption.
However, the phrase was first popularized in 1954 by Brooks Stevens, an American industrial designer. Stevens was due to give a talk at an advertising conference in Minneapolis in 1954. Without giving it much thought, he used the term as the title of his talk. From that point on, "planned obsolescence" became Stevens' catchphrase. By his definition, planned obsolescence was "Instilling in the buyer the desire to own something a little newer, a little better, a little sooner than is necessary."
The phrase was quickly taken up by others, but Stevens' definition was challenged. By the late 1950s, planned obsolescence had become a commonly used term for products designed to break easily or to quickly go out of style. In fact, the concept was so widely recognized that in 1959 Volkswagen mocked it in an advertising campaign. While acknowledging the widespread use of planned obsolescence among automobile manufacturers, Volkswagen pitched itself as an alternative. "We do not believe in planned obsolescence", the ads suggested. "We don't change a car for the sake of change."
In 1960, cultural critic Vance Packard published The Waste Makers, promoted as an exposé of "the systematic attempt of business to make us wasteful, debt-ridden, permanently discontented individuals".
Packard divided planned obsolescence into two sub categories: obsolescence of desirability and obsolescence of function. "Obsolescence of desirability", also called "psychological obsolescence", referred to marketers' attempts to wear out a product in the owner's mind. Packard quoted industrial designer George Nelson, who wrote: "Design... is an attempt to make a contribution through change. When no contribution is made or can be made, the only process available for giving the illusion of change is 'styling!'"

Types of planned obsolescence[edit]

Lifespan-limiting design[edit]

The design of all consumer products includes an expected average lifetime permeating all stages of development. Thus, it must be decided early in the design of a complex product how long it is designed to last so that each component can be made to those specifications. Since all matter is subject to entropy, it is impossible for any designed object to retain its full function forever; all products will ultimately break down, no matter what steps are taken. Limited lifespan is only a sign of planned obsolescence if the lifespan of the product is rendered artificially short by design.
A common method of deliberately limiting a product's useful life is to use inferior materials in critical areas, or deliberately suboptimal component layouts which cause excessive wear.[citation needed] Using soft metal in screws and cheap plastic instead of metal in stress-bearing components will increase the speed at which a product will become inoperable through normal usage and render it prone to breakage from even minor forms of abnormal usage. For example, small, brittle plastic gears in toys are extremely prone to damage if the toy is played with roughly, which can easily destroy key functions of the toy and force the purchase of a replacement.
Some products are powered by a battery (cell) that is soldered into the circuitry or enclosed in a sealed housing, instead of being easily replaced by a new battery. Although the product owner could resolder in a new battery, most owners will not bother or do not have the required skills. Some products contain rechargeable batteries that are not user-replaceable after they have worn down, so that consumers are required to pay for the manufacturer to replace the battery, or to buy a new product.
Planned obsolescence is sometimes achieved by placing a heat-sensitive component adjacent to a component that is expected to get hot. A common example is LCD screens with heat-sensitive electrolytic capacitors placed next to power components which may be 100 °C or hotter; this heat greatly reduces the lifespan of the electrolytic capacitor.[7]
The ultimate examples of such design are single-use versions of traditionally durable goods, such as disposable cameras, where the customer must purchase an entire new product after using them a single time. Such products are often designed to be impossible to service; for example, a cheap "throwaway" digital watch may have a casing which is simply sealed in the factory, with no designed ability for the user to access the interior without destroying the watch entirely.
Often the goal of such design is to make the cost of repairs comparable to the replacement cost, or to prevent any form of servicing of the product at all. In 2012, Toshiba was criticized for issuing cease-and-desist letters to the owner of a website that hosted its copyrighted repair manuals, to the detriment of the independent and home repair market.[8]

Style obsolescence[edit]

Obsolescence of desirability or stylistic obsolescence occurs when designers change the styling of products so customers will purchase products more frequently, due to the decrease in the perceived desirability of unfashionable items.
Many products are primarily desirable for aesthetic rather than functional reasons; the most obvious example of such a product is clothing. Such products experience a cycle of desirability referred to as a fashion cycle. By continually introducing new aesthetics, and retargeting or discontinuing older designs, a manufacturer can "ride the fashion cycle," allowing for constant sales despite that the original products remain fully functional. To a more limited extent this is also true of some consumer electronic products, where manufacturers will release slightly updated products at regular intervals and emphasize their value as status symbols.

Systemic obsolescence[edit]

Planned systemic obsolescence is the deliberate attempt to make a product obsolete by altering the system in which it is used in such a way as to make its continued use difficult. Common examples of planned systemic obsolescence include not accommodating for forward compatibility in software, or routinely changing screws or fasteners so that they cannot easily be operated with existing tools.

Programmed obsolescence[edit]

In some cases, notification may be combined with the deliberate disabling of a product to prevent it from working, thus requiring the buyer to purchase a replacement. Example: inkjet printer manufacturers who employ smart chips in their ink cartridges to prevent them from being used after a certain threshold (number of pages, time, etc.), even though the cartridge may still contain usable ink or could be refilled (with ink toners, up to 50% of the toner is often still full[9]). This constitutes programmed obsolescence, in that there is no random component to the decline in function.[citation needed]

Advantages and disadvantages of planned obsolescence[edit]

Further information: Waste hierarchy
Estimates of planned obsolescence can influence a company's decisions about product engineering. Therefore, the company can use the least expensive components that satisfy product lifetime projections.
Also, for industries, planned obsolescence stimulates demand by encouraging purchasers/putting them under pressure to buy sooner if they still want a functioning product. These products can be bought from the same manufacturer (a replacement part or a newer model), or from a competitor who might also rely on planned obsolescence.[1] Especially in developed countries (where many industries already face a saturated market), this technique is often necessary for producers to maintain their level of revenue.
While planned obsolescence is appealing to producers, it can also do significant harm to the society in the form of negative externalities. Continuously replacing, rather than repairing, products creates more waste and pollution, uses more natural resources, and results in more consumer spending. Planned obsolescence can thus have a negative impact on the environment in aggregate. Even when planned obsolescence might help to save scarce resources per unit produced, it tends to increase output in aggregate, since due to laws of supply and demand decreases in cost and price will eventually result in increases in demand and consumption. However, the negative environmental impacts of planned obsolescence are dependent also on the process of production.[10]
There is also the potential backlash of consumers who learn that the manufacturer invested money to make the product obsolete faster; such consumers might turn to a producer (if any exists) that offers a more durable alternative.
One workaround for consumers can involve a consumer getting more tech-savvy about them so they can jury-rig them to work with newer equipment similar to a MacGyverism; additionally, upcycling the resources can offset the budget for home projects, whereas downcycling allows for more generalized purposes to live on. These consumer strategies can counter the setbacks.

Critics and supporters[edit]

Shortening the replacement cycle has many critics as well as supporters.
Philip Kotler argues that: "Much so-called planned obsolescence is the working of the competitive and technological forces in a free society—forces that lead to ever-improving goods and services."[11]
Critics such as Vance Packard claim the process wastes and exploits customers. With psychological obsolescence, resources are used up making changes, often cosmetic changes, that are not of great value to the customer.
Some people, such as Ronny Balcaen, have proposed to create a new label to counter the diminishing quality of products due to the planned obsolescence technique.[9] Others have defended planned obsolescence as a necessary driving force behind innovation and economic growth.[citation needed]
Supporters claim planned obsolescence drives technological advances and contributes to material well-being. They claim that a market structure of planned obsolescence and rapid innovation may be preferred to long-lasting products and slow innovation. In a fast-paced competitive industry market success requires that products are made obsolete by actively developing replacements. Waiting for a competitor to make products obsolete is a sure guarantee of future demise.
A different case can be made for monopoly markets, or possibly for some oligopoly markets, where planned obsolescence may occur at the expense of the consumer. Jeremy Bulow argues that "monopolists are shown to desire uneconomically short useful lives for their goods. Oligopolists have the monopolist's incentive for short lives as well as a second incentive that may either increase or decrease their chosen durability."[2]
This poses the following ethical dilemma: while planned obsolescence may help to accelerate innovation, economic growth and improve wellbeing of consumers, it is true that it may also create social costs by harming the environment. According to Joseph Guiltinan "Pro-environment product design and marketing practices and innovative government policies may alleviate the problem over time. However, given the current lack of understanding about consumer replacement and disposal behavior, it is questionable as to whether these practices and policies will be sufficiently informed to be effective."[10]

Planned obsolescence in software[edit]

Software companies are sometimes thought to deliberately drop support for older technologies as a calculated attempt to force users to purchase new products to replace those made obsolete.[12] Most proprietary software will ultimately reach an end-of-life point, at which the supplier will cease updates and support. As open source software can always be updated and maintained by somebody else, the user is not at the sole mercy of a proprietary vendor.[13] Software which is abandoned by the manufacturer support-wise is sometimes called abandonware.
Vendor lock-in through incompatibility, DRM, and hardware restriction can effectively expand obsolescence of a "part" to the "whole" product, although each of the parts could otherwise be general-purpose. A personal computer that due to deliberate restrictions can only run a specific operating system, which only allows playback of files from a specific source, becomes significantly less useful when the source is not available any more.

The Future of Planned Obsolescence[edit]

Planned obsolescence has been assumed a necessity when it comes to stimulating consumption, however, this practice has come into question. In the 21st century, the arrival of economic and environmental crisis has made a change in the consciousness of people. The need to maintain a minimum product renewal date does not mean that abuses have to be accepted such as the tons of waste that could be avoided.
After years of not taking this issue seriously, the French Assembly has taken a step forward. It has established a fine of up to 300,000 euros and jail terms of up to two years for those manufacturers planning the death of their products in advance. The rule is not only relevant because of the sanctions that it establishes but also because it is the first time that a legislation recognizes openly the existence of planned obsolescence. These techniques may include "a deliberate introduction of a flaw, a weakness, a scheduled stop, a technical limitation, incompatibility or other obstacles for repair", reads the text regarding what may be considered as planned obsolescence.
France is not the only government in which this kind of practice is being used. The European Union is also beginning to address this problem. The European Economic and Social Committee (EESC), an advisory body of the EU, has approved a dictum which totally bans planned obsolescence. This dictum also proposes additional measures to combat this practice. "We propose three lines of action. Firstly, companies can facilitate repair. Secondly, the use of social awareness campaigns to combat aesthetic obsolescence; the constant renewal of unused products, particularly clothes and telephones. And finally, the introduction of a labeling system which indicates the durability of a device, so the consumer has the possibility of choosing whether if he/she prefers to buy a cheap product or a more expensive, more durable product", explains Carlos Trias Pinto, president of the Consultative Commission on Industrial Change EESC, the group that developed the dictum. All in all, what is clear is that the movement against planned obsolescence Is strong in the EU which may also lead in the implementation of similar dicta in the rest of the continents as well.[14]

See also[edit]

References[edit]

  1. ^ Jump up to: a b "Computer Electronics: Blu-Ray". ComputerInfoWeb.com. 2008. Retrieved September 20, 2008. 
  2. ^ Jump up to: a b Bulow, Jeremy (November 1986). "An Economic Theory of Planned Obsolescence" (PDF). The Quarterly Journal of Economics (New York: John Wiley & Sons, Inc.) 101 (4): 729–749. doi:10.2307/1884176. Retrieved April 9, 2013. 
  3. Jump up ^ Orbach, Barak (2004). "The Durapolist Puzzle: Monopoly Power in Durable-Goods Market". Yale Journal on Regulation, vol. 21, pp. 67–118. Retrieved May 18, 2008. 
  4. Jump up ^ Dickinson, Torry D.; Schaeffer, Robert K. (2001). Fast Forward: Work, Gender, and Protest in a Changing World. Rowman & Littlefield. pp. 55–6. ISBN 0-7425-0895-1. 
  5. Jump up ^ Babaian, Sharon (1998). The Most Benevolent Machine: A Historical Assessment of Cycles in Canada. Ottawa: National Museum of Science and Technology. p. 97. ISBN 0-660-91670-3. 
  6. Jump up ^ Bernard London's pamphlet
  7. Jump up ^ http://htv-gmbh.de/media/pdf/presse/Testhaus_HTV_deckt_Sollbruchstellen_auf_%28Infosat_07_-_2013%29.pdf
  8. Jump up ^ The Shady World of Repair Manuals: Copyrighting for Planned Obsolescence | Wired Opinion | Wired.com
  9. ^ Jump up to: a b RTBF documentary "L'obsolescence programmée" by Xavier Vanbuggenhout
  10. ^ Jump up to: a b Guiltinan, Joseph Guiltinan (2009). "Creative Destruction and Destructive Creations: Environmental Ethics and Planned Obsolescence". Journal of Business Ethics 89. 
  11. Jump up ^ "Planned obsolescence". The Economists. Retrieved 8 February 2014. 
  12. Jump up ^ "Idea: Planned obsolescence". The Economist. March 25, 2009. Retrieved May 29, 2011. 
  13. Jump up ^ Cassia, Fernando (March 28, 2007). "Open Source, the only weapon against 'planned obsolescence'". The Inquirer. Retrieved August 2, 2012. 
  14. Jump up ^ Lavadoras con muerte anunciada. (2014, November 2). Retrieved May 19, 2015, from http://economia.elpais.com/economia/2014/10/31/actualidad/1414761553_335774.html

Further reading[edit]

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