Keeping up with the Joneses: the Relevance of Duesenberry’s Relative Income Hypothesis in Ethiopia

Abstract

Although it was mysteriously neglected and displaced by the mainstream consumption theories, the Duesenberry’s relative income hypothesis seems quite relevant to the modern societies where individuals are increasingly obsessed with their social status. Accordingly, this study aims to investigate the relevance of Duesenberry’s demonstration and ratchet effects in Ethiopia using a quarterly data from 1999/2000Q1-2018/19Q4. To this end, two specifications of relative income hypothesis are estimated using Autoregressive Distributed Lag (ARDL) regression model. The results confirm a backward-J shaped demonstration effect. This implies that an increase in relative income induces a steeper reduction in Average Propensity to consume (APC) at lower income groups (the demonstration effect is stronger for lower income households). The results also support the ratchet effect, indicating the importance of past consumption habits for current consumption decisions. In resolving the consumption puzzle, the presence of demonstration and ratchet effects reflects a stable APC in the long-run. Hence, consumption-related policies should be carefully designed as polices aimed at boosting aggregate demand can motivate low income households to gallop into wasteful competition so as to ‘keep up with the Joneses’—the relative riches.

Prevalence of Duesenberry’s Relative Income Hypothesis in Nepalese Economy

“…The consumption of a family is determined by the consumption of its surroundings. Khan (2014, as cited in Bisset andTenaw, 2020) and Masson (2020, as cited in Bisset and Tenaw, 2020) argued that consumption of a family primarily depends on the highest level of income of that family previously attained and consumption pattern of the neighbors. At previously attained highest income, consumption of the family was also high.…”

“…According to Bisset and Tenaw (2020), we can use DEF and Davis-SK specifications to test Duesenberry's demonstration effect and ratchet effect in the empirical analysis assuming APC is the linear function of relative income which implies demonstration effect is same across the households within different income groups.…”

“…McCormick (2018, as cited in Bisset and Tenaw, 2020) argued that lower-income people have the constant pressure to consume more, while high-income people have less pressure to spend more than before. This implies that poor people have higher APC and rich people have lower APC.…”