Could It be Profitable to be a Fool in the Market?

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Among many others, there is a fundamental assumption in mainstream economics when it comes to people. The assumption is that people are rational. Given the costs, a rational consumer would analyze the benefits accruing from a particular opportunity and then make a suitable decision for themselves. Rationality is heavily dependent on the information that an individual possesses about market conditions. Perfect knowledge would allow people to assess the situation better and take rational, logical and economically viable decisions. Many models are based on this assumption of rationality. This is, however, existent only in the theoretical models described in economic textbooks. Information asymmetry exists in the real world. Some people can exploit this and hence, can make substantial gains while others can lose. Also, it is often the case that people might not act rationally even in the face of perfect knowledge. In fact, behavioural economics challenges the very notion of human rationality and proposes that people act irrationally due to a plethora of reasons. One of the most interesting manifestations of human irrationality is the Greater Fool Theory.

As the name suggests, there are, at least, 2 parties involved in the theory. Both of them have been consumers of the same sort for the same good at some point in time. In rudimentary terms, the Greater Fool Theory states that it is possible to make money by purchasing items, usually overpriced, at an early stage and later selling them to a person who will pay a higher amount for the same good (Borgan, 2019). In this case, the initial buyer is a fool for purchasing an item for a price greater than its intrinsic value. However, they have found a buyer who is willing to pay an even higher amount than they did. This would make the transaction beneficial and lucrative for the initial buyer. The flip side of it is that it would make the second buyer “the greater fool” unless they too can find someone willing to pay a higher price than what they paid. The process continues until people realize the fact that the price they paid for the good is astronomically high and hence is not commensurate to its fundamental value.

Why would the initial buyer purchase an item at a price higher than its intrinsic value? Under recorded circumstances, most people would purchase an item priced over its inherent value when there is a chance of reselling the product at a higher price and thereby earning a handsome profit. This seems like a rational thing to do since prospective gains seem to outweigh costs. This would imply that the price for the good would later rise up quite significantly. Since it was already overpriced, the price that would rise over time would be far greater than the intrinsic value of the good. This is called, in economic lingo, a bubble. It is an event in which prices rise dramatically and increase beyond their fundamental value. Some prime examples of bubbles include the Dutch Tulip Mania, dot-com bubble among many others. In all of these cases, assets/securities were overhyped and sold at extravagant prices to ready customers. The existence of the greater fool comes out when the bubble bursts. In fact, literature tells us that the theory is usually in place when there is already a bubble in the market. Since fools wanting to own the good exist in the market, they overpay to ensure possession of the good. Hence, the price of the item increases. This prolongs the bubble and hence, in all probability, changes who the greater fool would ultimately be.

However, another aspect of why would someone pay an extraordinarily high sum for a commodity that is not worth it is best explained as human irrationality. It suggests that human beings sometimes make purchases for reasons such as gaining prestige in society, following a recent trend etc. In those cases, a consumer tends to forget about the price tag and pays an incredulous amount of money. Take the example of Supreme, for instance. Even though it is an apparel brand, it sells practically anything on which it can imprint its iconic logo. This includes the “Supreme Brick” which is an 8-inch long red clay brick. Its retail price is $30. Nonetheless, in resale markets like eBay, it is sold as high as $1000. Now that is a pretty major upgrade on the price. Anyone who pays $30 for the brick might seem like a fool because they are already paying 6000% more than the average price of a brick (Pursell, 2019). What would someone willing to pay an even higher sum than that be called? A greater fool. Some people, nevertheless, re-sell it at a lower price of $150 (Lichtenstadter, 2016) which is still nearly 500% more than the retail charge.

Why are people so crazy about Supreme products? There is a lot of content written on the subject. It has got everything a successful marketer dreams of- a massive fan following, strategic collaborations with luxury brands, celebrity endorsements and above all, consumer hype about its product. However, for fans, Supreme is more than a brand; it is an emotion and a way of life (Houston & Fennell, 2019). That would explain why it can easily sell items like crowbars, bricks etc. Because of its limited supply, owing anything from Supreme allows people to belong to an exclusive stratum of the society. Another reason is that owning items by Supreme makes people look ‘cool’. To be a part of that cohort, people overpay. They forget about the intrinsic value of the commodity and tend to focus on the logo imprint. Many people exploit this irrational behaviour of most Supreme fans. Therefore, they buy goods directly from the website which are only slightly overpriced (a relatively foolish step), only to sell it at a higher rate later on resale websites like Craigslist or Stockx. In fact, most of the valued transactions that take place for Supreme items happen in the resale market where items can be sold as high as 30 times the retail price. This might be a parochial example but it does show that fools and greater fools exist in the market. While nothing can be said about the existence of a Supreme bubble since there is only a limited amount of Supreme products in the market, it does corroborate that people would use the Greater Fool Theory to make money off these items.

In a nutshell, it is okay to be a fool in the market as long as there is a greater fool in the market who will overpay for the item under consideration. The trick is to ensure that you are not the greater fool.

References:

1. Borgan, V. (2019, February 14). The Greater Fool Theory: What Is It? Hartford Funds. https://www.hartfordfunds.com/investor-insight/the-greater-fool-theory-what-is-it.html

2. Lichtenstadter, M. (2016, October 2). People like this red clay brick so much that it’s now going for $1,000 on eBay. The Comeback. https://thecomeback.com/general/people-are-actually-paying-1000-for-this-brick-on-ebay.html

3. Pursell, R. (2019, December 5). Skate brand Supreme sells clay bricks for $30, the internet takes the bait. Men’s Journal. https://www.mensjournal.com/adventure/skate-brand-supreme-sells-clay-bricks-for-30-internet-goes-wild/

4. Houston, J., & Fennell, N. (2019, May 17). How Supreme went from a small skateboarding store in New York to an $1 billion streetwear company with a cult. Business Insider. https://www.businessinsider.in/retail/how-supreme-went-from-a-small-skateboarding-store-in-new-york-to-an-1-billion-streetwear-company-with-a-cult-like-following-among-teens/articleshow/69378463.cms

Cover image credits: gq.com

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