A Diamond Pricing Puzzle

In our textbook, Modern Principles of Economics, Tyler and I predicted that lab grown diamonds would break the DeBeers cartel. Well, it’s finally happening.

Bloomberg: One of the world’s most popular types of rough diamonds has plunged into a pricing free fall, as an increasing number of Americans choose engagement rings made from lab-grown stones instead.

…the scale and speed of the pricing collapse of one of the diamond industry’s most important products has left the market reeling.

…De Beers has cut prices in the category by more than 40% in the past year…The impact on De Beers was clear…first half profits plunged more than 60% to just $347 million, with its average selling price falling from $213 per carat to $163 per carat.

The puzzle, however, is why has it taken so long? The diamond market does have some peculiar features. Buyers of engagement rings don’t necessarily benefit from lower-prices per se as a diamond ring is a signal. If the cost of the signal goes down, people need to spend more to send the same message. An inexpensive engagement ring is thus something of a contradiction in terms, so price shopping is less intense. Nevertheless, the early buyers of lab-grown diamond rings should still benefit because the rings can’t be distinguished by the naked eye. Neither the bride, nor her friends, have to know the $10,000 ring only cost $5,000, right? Right?

Well maybe not right. DeBeers also produces lab-grown diamonds and they have a very strange pricing strategy:

De Beers started selling its own lab-grown diamonds in 2018 at a steep discount to the going price, in an attempt to differentiate between the two categories. The company expects lab-grown prices to continue to tumble, in what it sees as a tsunami of more supply coming on to the market, Rowley said. That should create an even bigger delta in prices between natural diamonds and lab grown, helping differentiate the two products, he said.

What? Ordinarily, the bigger the price between a competitor and its substitute the greater pressure on the competitor to lower prices! Yet DeBeers is gambling that the bigger the difference in price between natural and lab grown diamonds the bigger the demand for natural diamonds! Strange. The only way I see this working is if the fiancée knows the price of the ring, which maybe they do! In that case, the buyer still has to spend 10k and doesn’t care whether it’s 10k on synthetic diamonds or 10k on natural grown diamonds. But 10k on synthetic diamonds will get you more carats so we need an equilibrium in which a smaller diamond signals more expensive. But that runs against hundreds of years of expectations! And remember natural and lab grown diamonds are indistinguishable by the naked eye. It’s one thing for the fiancée to know the price of the diamond but surely her friends judge by what they can see, namely the size of the ring. Which signal is the most important to send?

by Alex Taborrok, Marginal Revolution |  Read more:

Image: Maciej Frolow

[ed. Don't have Bloomberg, so here's an economic analysis.  But... they can print perfect diamonds now?]