The Behavior of Other as a Reference Point
41 Pages Posted: 2 Sep 2015
Date Written: August 26, 2015
We use prospect theory to model reference dependent consumers, where the reference point is the average behavior of the society in the current period. We show that after a finite number of steps under any equilibrium, the distribution of wealth will become and remain equal, or admit a missing class (a particular form of polarization). Under equilibria that admit the highest growth rates, the initial wealth distribution that maximizes this growth rate is one of perfect equality. Conversely, under equilibria that admit the lowest growth rates, perfect equality minimizes this growth rate and societies with a small level of initial inequality grow the fastest. In addition growth rates in corresponding economics without reference dependent consumers admit lower growth rates.
Keywords: Prospect Theory, Reference-dependence, Aspirations
JEL Classification: D11; D91
Suggested Citation: Suggested Citation