The Social Basis of Interdependent Preferences

Most economists are sympathetic to the idea that concerns for relative position are an important aspect of many economic problems. There has traditionally been a reluctance to include such concerns primarily because models that included them often allow such a broad range of behavior that there are few, if any, restrictions on equilibrium behavior and, hence, such models would have little or no predictive power. In this paper we discuss how reduced form models may naturally give rise to utility functions that depend, in part, on relative standing. There are several advantages of modelling concern for relative standing in reduced form utility functions even when there is no similar concern in the "deep" preferences. It provides structure and constraints on the way that relative standing affects utility, and further, it can yield testable implications about the way that changes in the underlying environment affect the concern for relative standing. We discuss the advantages and disadvantages of modelling social concerns in this way and provide examples that illustrate how concerns for relative standing can affect savings, investment and labor choice decisions.

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