Expenditure Cascades

Abstract

Prevailing economic models of consumer behavior completely ignore the welldocumented link between context and evaluation. We propose and test a theory that explicitly incorporates this link. Changes in one group's spending shift the frame of reference that defines consumption standards for others just below them on the income scale, giving rise to expenditure cascades. Our model, a descendant of James Duesenberry's relative income hypothesis, predicts the observed ways in which individual savings rates respond to changes in both own and others' permanent income, as well as numerous other stylized fact patterns that are difficult to reconcile with prevailing models. Evaluative judgments are known to depend heavily on context. For example, the same car that would have been experienced by most drivers as having brisk acceleration in 1950 would seem sluggish to most drivers today. Similarly, a house of given size is more likely to be viewed as adequate the larger it is relative to other houses in the same local environment. And an effective interview suit is simply one that compares favorably with those worn by other applicants for the same job.

“Relative concerns for consumption at the top”: An intertemporal analysis for the UK

“…This does not imply that increasing consumption among rich households leads nonrich households to excessively increase their consumption levels as it is argued in Frank et al (2010) or in Bertrand and Morse (2013). Indeed, households recognise that increasing consumption today to keep up with their rich neighbours would lead to lower relative consumption in the future.…”

“…Frank et al (2010) argue that households compare their consumption to the consumption of those who are located only slightly higher in the income distribution. Thus, while the consumption of the rich may be a reference point for the middle class, lower income households may instead compare their consumption to the consumption of middle-income households.…”

“…Bertrand and Morse (2013), using data from the Consumer Expenditure Survey (CEX), provide evidence that higher income and consumption among rich households have induced non-rich households to consume a larger fraction of their income. Frank et al (2010) suggest that households compare their consumption with the consumption of households that are located slightly higher in the distribution of income. In their model, an increase in income and consumption at the top can generate "expenditure cascades" that ripple all the way through the income distribution.…”

Does income inequality affect aggregate consumption? Revisiting the evidence

“…In Frank et al (2010), the link between the propensity to consume and inequality is explained through so-called expenditure cascades. Frank et al (2010) provide a framework that moves away from the permanent income hypothesis and propose a context-dependent setting where the savings rate of a given income group will be affected by inequality within the group.…”

“…Frank et al (2010) provide a framework that moves away from the permanent income hypothesis and propose a context-dependent setting where the savings rate of a given income group will be affected by inequality within the group. The model predicts decreases in the savings rate with increasing inequality and links such a result empirically to the observation of decreasing saving rates and growing inequalities in the USA.…”