The impact of a reference point determined by social comparison on wealth growth and inequality

Abstract

We study the impact of a reference point determined by social comparison on wealth growth and inequality. The reference point of each individual investor contains both personal and social components. Whereas the personal component depends on the investor’s own history of wealth, the social component is determined by the wealth level of other investors in her network. In the benchmark case without social interactions and under the assumption of homogeneous preferences, each investor’s expected wealth grows at a common rate, the wealth gaps widens and the Gini coefficient remains constant. On the other hand, if the reference point is determined solely by social interactions, then it is possible that the network simultaneously experiences high wealth growth and a reduction in inequality. Finally, for the general case where the reference point incorporates both personal and social components and some extensions of the model, we numerically show that increasing the degree of social interactions is beneficial for both increasing wealth growth and reducing inequality.