Peer Pressure with Inequity Aversion

Abstract

To examine the effects of peer pressure on outputs under symmetric and asymmetric information, we define a peer pressure function representing psychological costs and incorporate it into the agent’s utility function. Under symmetric information, an efficient agent who is averse to inequity (i.e., suffering from being ahead) produces less than he does without peer pressure whereas an inefficient agent suffering from being behind produces more such that the output gap between the two types of agents is lessened. Moreover, overproduction in total output will occur if the inefficient agent’s disadvantage inequity aversion is greater than that of the efficient agent’s. However, as the information structure becomes asymmetric, the overproduction disappears because the information rent paid to the efficient agent becomes too burdensome so that it countervails the active peer pressure effect. These results are consistent with previous findings from empirical and experimental studies.