Tunnel Effects, Inequality Aversion and the Taste for Status: A Formal Model

Abstract

Hirschman and Rothschild’s (1973) tunnel effect refers to the propensity for individuals to be pleased by the success of others if they believe this signals an improvement in their own prospects. Tunnel effects are subject to two claims in the current literature on happiness: that they partly or fully offset the utility losses from increases in peer income levels or income inequality. I develop a simple model of tunnel effects to evaluate these two channels of influence. The analysis confirms that tunnel effects create a positive link between happiness and economic growth. In contrast, with a rise in income inequality, tunnel effects increase the happiness of the rich but decrease happiness among the poor. Finally, tunnel effects increase happiness when rising inequality is accompanied by economic growth, which is the case that concerned Hirschman and Rothschild. I close by discussing the model’s implications for appropriate empirical specifications for investigating inequality aversion.