Lipstick Effect: Definition, Theory, Value as Economic Indicator

What Is the Lipstick Effect?

The lipstick effect is when consumers still spend money on small indulgences during recessions, economic downturns, or when they personally have little cash. They do not have enough to spend on big-ticket luxury items; however, many still find the cash for purchases of small luxury items, such as premium lipstick. For this reason, companies that benefit from the lipstick effect tend to be resilient even during economic downturns.

Understanding the Lipstick Effect

The lipstick effect is a manifestation of something that economists call the income effect. Economists break down consumer demand for any given product as a combination of the effects of the price of a good relative to other goods, known as the substitution effect, and the consumer's income, known as the income effect.

For normal goods, as a consumer's income rises, so does demand. However, for some goods, known as inferior goods, rising consumer income actually weakens demand, and vice versa. Cheap domestic beer is a classic example of an inferior good.

This is what occurs in the case of the lipstick effect. As consumers' incomes fall, they will forgo big-ticket luxury goods purchases that they can no longer afford and instead spend their (reduced) discretionary income on smaller luxury items.

The lipstick effect is one of the reasons that fast-casual restaurants and movie complexes typically do well amid recessions. Cash-strapped consumers want to treat themselves to something that lets them forget their financial problems. They can't afford to escape to Bermuda. However, they’ll settle for a fairly cheap night out and a movie, adjusting their budget accordingly.

Another theoretical basis for the lipstick effect is that during times of economic recession, labor markets become more competitive. This can lead job seekers to spend more on goods that enhance their perceived advantages over other candidate employees in order to get or keep a job. Paying more attention to the visible aspects of one's job market appeal by using more or better cosmetics can be one way of doing this.

Pros and Cons of the Lipstick Effect as an Indicator

Lipstick as an economic indicator makes sense. Unlike the Super Bowl indicator, which is a spurious market indicator that few take seriously, the lipstick indicator is firmly based on economic theory.

One of the only problems with the lipstick indicator is that it can be difficult for the public to access sales data on lipstick and similar products at regular intervals, such as weekly or monthly.

The U.S. Bureau of Economic Analysis (BEA) publishes quarterly data revealing personal consumption expenditures on "cosmetic/perfumes/bath/nail preparations and implements," while the U.S. Census publishes monthly data on retail sales by "health and personal care stores" but with a few months of lag time. In short, the lack of timely data limits the usefulness of the lipstick effect to predict economic downturns.

As a result, the lipstick indicator helps the chair of Estée Lauder know how to plan his budget, but it’s of no practical use to a regular mom-and-pop investor, unless they also can easily track lipstick sales.

Also, it's worth noting that if an economic contraction is severe enough, incomes continue to fall, and consumers may tend to eschew even small indulgences. Theoretically, at least, sales of lipstick or Starbucks coffee fail to be predictive when sales of pretty much everything contracts at the same time.