A Pedagogical Model of the Relative Income Hypothesis

Abstract

Duesenberry's (1949) relative income hypothesis holds substantial empirical credibility, as well as a rich set of implications. Though familiar to the pages of leading economics journals, the hypothesis is all but foreign to the blackboards of economics classrooms. With the intention of introducing the concept to undergraduate economics students, this paper constructs a simple pedagogical model of the relative income hypothesis. The model extends upon the standard consumer choice problem to help students understand how positional considerations might influence a representative consumer's utility maximizing behavior. Properties and implications of the hypothesis, including negative spending externalities, wasteful spending races, the effect of forced retirement savings programs upon wasteful spending races, and the Pareto implications of universal income growth, are illustrated within a two-good consumption space.