Estimating Income-Dependent Relative Income Effects in the UK

Abstract

Duesenberry’s (Income, saving, and the theory of consumer behavior. Harvard University Press, Cambridge, 1949) relative income hypothesis says that the utility of an individual depends not only on his absolute income level, but also on his relative income position in society. An individual gains utility if his income exceeds the income of most members in his comparison group and loses utility if his income falls below the income of most members in the group. Many empirical studies already show that these relative income effects have a significant role in determining well-being. However, most of them consider a symmetric case where the relative effects are homogenous among the population, or a simple version of an asymmetric case in which the population is categorized into two groups, conditioning on whether one’s income level is higher or lower than the income level of his reference group. The nature of relative income effects may be much more complicated, however, as two similarly-situated individuals may feel differently about their relative positions. The current analysis uses the British Household Panel Survey to depict a broader heterogeneity—income-dependent relative income effects. To explore the empirical possibility of income-dependent relative income effects, we regress a utility proxy on own income, the average income of the reference group, and an interaction of the two. Results suggest that one’s relative income effect indeed depends on one’s current income level.