With A Downturn In The Business Cycle, Gresham’s Law Proves More Emphasis on Quality

Gresham's Law

Sir Thomas Gresham advised the English royalty on economic matters in the 16th Century and helped the crown to stabilize the value of its money by arguing for the usage of less precious metal in the manufacture of coins. He reportedly uttered what is now known as “Gresham’s Law” that “bad money drives out good,” that is, that when people begin to use newly minted coins—whatever their real value—those new coins will be considered equally valuable to previous editions, and the older, more precious coins will disappear from the marketplace as people hoard them.

Gresham’s Law was not a concept that swept the economic world during his time, but centuries later, it was frequently referenced as other countries struggled with their currency circulations and values. Gresham’s Law has now been expanded by some economists to cover just about any type of good, with the idea that if poorly made goods are rushed to market under the guise of high quality and trendiness, many consumers will be fooled to think that they are top of the line. This puts a premium on getting goods to the market, especially in the area of technology, rather than endlessly tinkering with such goods to achieve near-perfection. The assumption is that consumers are not able to calculate real value, and they will buy up new goods that are perceived as the latest breakthroughs, even if the quality is sub-standard. Studies have proven the truth of Gresham’s Law in this sphere.

Low Quality Passed Off As High Quality

To re-state Gresham’s Law as it is discussed today, it is commonly believed that if a low-quality good is passed off as high-quality, then the market will drive down prices due to the fact that consumers will not be able to determine the good’s true and real value. Far beyond the intricacies of currency circulation, Gresham’s Law is re-emerging as a fact in the marketplace.

The story of many, many goods and their marketing can be used to prove the truth of Gresham’s Law, as consumers have difficulty determining a good’s real value. Gresham’s Law is probably more true than ever in a depressed business cycle, such as the one that we are in today, because people are not thinking long term or calculating intrinsic values as they make purchases.

Here’s an example of Gresham’s Law in action

Various manufacturers develop a portable digital camera. Manufacturer A comes up with a model that does not take great photos but is highly functional and can be produced cheaply, then sold for $150. Manufacturer B cares more about the quality of its digital camera and spends added months refining the inner works of its camera so that it will take high-resolution photos that are of near-professional quality.

Manufacturer A launches its camera during the holiday season, for instance. Manufacturer B waits to perfect its camera and launches six months later. According to Gresham’s Law, what will occur? Gresham would argue, were he alive today, that Manufacturer A will establish the price and value of a digital camera, despite its lower quality. And, in fact, we now know that he would be exactly right.

Manufacturer A will sell millions of cameras as consumers gobble up the first portable, affordable digital camera available. Manufacturer B will roll out its model with a huge ad campaign, but consumers will have already decided that a good digital camera costs $150, not $250, no matter how wonderful the photos are that emerge from the more expensive model. Manufacturer B will still gain a slice of the market, but only among true photo aficionados that care deeply about the quality of their photos. In this case, bad cameras almost completely drive good cameras out of the market.

Think about Gresham’s Law

The next time a new technology is launched, whether it be flat screen TVs, portable phones or bagless vacuum cleaners. In many, if not all cases, the cheaper entries into the market will often overwhelm the more high-quality entries, especially if they are the first to gain space on store shelves. Consumers are not known for their ability to calculate real value or consider intrinsic values when making purchases. They usually opt for functional and affordable over long-lasting and more expensive.