Running to Keep in the Same Place:Consumer Choice as a Game of Status

Thomson LectureOctober 2nd, 2006

Ed Hopkins & Tatiana Kornienko

The Red Queen

“Well, in our country”, said Alice, panting a little, “you'd generally get somewhere else if you ran very fast for a long time, as we've been doing”.

“A slow sort of country!” said the Queen. “Now here, you see, it takes all the running you can do to keep in the same place.”

Are We Living in a Red Queen Economy? Do we all work too hard and spend too

much? If so, is it because we are comparing

ourselves with “the Joneses”? If we are competitive in consumption,

does greater inequality make us all worse off?

Are higher taxes good for you?

What Makes Us Happy? Standard economic theory

assumes that a person’s happiness (utility) depends on her own consumption and her own leisure

It is only recently that economists have begun to consider “social preferences”: the idea that satisfaction may depend on what others receive as well as one’s own material position

Empirical Evidence

There is now many years of data from large scale surveys in many countries that include questions on life satisfaction.

For example, are you currently “very happy”, “pretty happy” or “not too happy”?

If one looks at a particular year, it does appear that happiness rises with income….

Happiness and Income, USA, 1994

1.8

2

2.2

2.4

2.6

2.8

3

Less than$10,000

$10-19,999

$20-29,999

$30-39,999

$40-49,999

$50-74,999

$75,000and over

Income Category

Avera

ge H

appin

ess

However, average happiness has not risen over time, even though incomes have.

The Happiness Paradox

Looking at data from a single year suggests that happiness increases with income, looking at average happiness across many years suggests that it does not.

One possible resolution of the paradox is that it is relative income not absolute income that is important.

It is not being rich, but being richer than other people that matters.

Neighbours as Negatives

Prosperous neighbours can make us feel worse off.

Detailed evidence that richer neighbours lead to lower happiness, longer hours worked and more frequent marital arguments (Luttmer, 2005).

But how does the income of others affect us?

Conspicuous Consumption

Thorstein Veblen coined the term “conspicuous consumption” in his book The Theory of the Leisure Class (1899).

He argued that some consumption is intended to send a message about the consumer’s status rather than just to satisfy need.

Luxuries are like Pollution?

Robert Frank in the US and Richard Layard in the UK have both claimed that conspicuous consumption has significant “negative externalities”.

My consumption expenditure can make you feel miserable

It also diverts funds away from saving, leisure, time spent with friends and family, all goods that are not conspicuous.

A Consumer’s Dilemma

Consumer 2 ►Consumer 1

▼

SUV Small Car

SUV

0, 0 3, -1

Small Car

-1, 3 2, 2

Taxes to the Rescue?

Economic theory suggests that there is actually a “free lunch” from taxing negatives like pollution rather than positives like labour supply.

Maybe the luxury consumption of the rich poisons our social atmosphere.

Frank and Layard have used this as an argument for progressive taxes on consumption.

Status and Inequality

Thus, status concerns seem to give new support for greater equality.

However, is this really the case? Economic theory can check the logical

coherence of this argument that greater inequality feeds greater conspicuous consumption and lowers happiness.

But to do so, we need a somewhat more complicated model than the simple consumer’s dilemma.

A Game of Status

Assume a large population of individuals who differ only in income.

Both conspicuous and non-conspicuous consumption have some intrinsic benefits.

People also care about their rank in visible or conspicuous consumption.

E.g. if you have the most expensive car you have a rank of 1, the least a rank of 0, and your utility increases in this rank.

A Game of Status – The Decision Problem Each consumer must divide her income

between conspicuous and non-conspicuous consumption.

Conspicuous consumption has both a direct benefit and the effect on one’s rank.

Exactly how much will be the effect on rank depends on the consumption choices of others.

How Much Should I Consume? Suppose all consumers were not

competitive and chose the level of consumption on the basis of its intrinsic usefulness, the privately optimal level.

Then, status would mimic rank in income simply because the richest people would have the largest cars and biggest houses.

However, any individual spending more on visible consumption would see his status rise.

Everyone has an incentive to spend more.

Finding a Balance

The defining characteristic of economic theory is equilibrium analysis. Here, we try to find a Nash equilibrium.

We have to find a level of consumption for each individual, a consumption schedule, such that no individual could do better by changing strategy.

Note that if two people with differing income choose the same level of conspicuous consumption, the richer can always spend more.

And we assume spending just that bit more is less painful for the richer (single crossing condition).

Marginal Benefit and Cost of Conspicuous Consumption

Conspicuous Consumption→

Mar

ginal

Ben

efit/C

ost

Marginal BenefitMarginal Cost PoorMarginal Cost Rich

Finding a Balance (contd.)

We have argued that spending just that bit more is less painful for the richer (single crossing condition).

Thus, we can find a consumption schedule which is sufficiently steep with respect to income so that the poor do not want to increase consumption to overtake the rich (separating outcome).

But this implies that in equilibrium, spending on conspicuous consumption must be increasing in income.

Staying in the Same Place

Since the equilibrium consumption schedule is increasing in income, in equilibrium, status exactly reflects one’s place in the distribution of income.

Everyone has increased expenditure on conspicuous consumption, only to remain in the same relative position.

Everyone could be made better off if everyone signed a truce simply to spend the privately optimal amount.

Equilibrium Consumption Schedule

Income

Con

sum

ption

Equilibrium

PrivatelyOptimal

The Distribution of Income and Conspicuous Consumption The real innovation in our analysis is that

we show that this equilibrium schedule of conspicuous consumption depends on the distribution of income (like a first price auction rather than Spence’s model of signalling).

We can also determine how consumption changes with the income distribution.

The crucial question is whether greater inequality increases or decreases the level of competition.

Standing Out from the Herd

But how to analyse the effect of inequality?

In the paper, there is a mathematical argument involving differential equations and refinements of second order stochastic dominance.

But it is easier to make a simple point…

Return to Conspicuous Consumption Depends on the Social Density

The more people are alike, the easier it is to stand out.

The more people are alike in income, the easier it is to overtake them in conspicuous consumption.

Greater equality leads to a higher return from competitive consumption and, thus, more consumption.

Since everybody already consumes too much, this can lead to a general reduction in utility.

The Effect of Redistribution

Greater equality raises the social density leading to more competitive consumption and possibly lower utility at every income level.

For example, here the income distribution has been compressed from [£100, £600] to [£200, £500].

100 200 300 400 500 600

Income

Utility

MoreEqual

LessEqual

Turning to Taxes

The argument of Robert Frank and Richard Layard still holds in part.

Taxes on consumption in such a model could be corrective rather than distortionary. That is, by reducing competition, they could make everyone better off.

The problem is that such taxes are unlikely to be progressive.

Greater Equality can be Bad for the Lower and Middle

Classes This is a dismal result that is best

interpreted as check on the logic of certain arguments rather than as a policy prescription.

The lessons are that there may be unexpected consequences

of any policy intervention; in making economic arguments, the

conclusions you would like to get do not always follow from the assumptions that you would like to make.

Conclusions and Further Directions

We have looked at a game of status and found some surprising conclusions.

In such a situation, an increase in equality leads to greater social competition and to lower welfare, particularly for those with low or middle incomes.

Since writing this paper, we have continued to work on models of social competition.

In a richer model we identify different types of equality, some of which can reduce wasteful competition, rather than increase it.

But that is a different tale for another day.