Expenditure Cascades

Evaluative judgments are known to depend heavily on context. For example, the same car that would have been experienced 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 one that compares favorably with those worn by other applicants for the same job. Although the link between context and evaluation is uncontroversial among behavioral scientists, the reigning economic models of consumer behavior completely ignore it. These models assume that each person’s consumption spending is completely independent of the spending of others. In contrast, James Duesenberry’s relative income hypothesis explicitly acknowledges the link between context and evaluation. In this paper we employ a variant of his model to explore the relationship between context and spending patterns. In this effort, we exploit data that allow us to quantify the effects of substantial increases in income inequality that have occurred in recent decades. According to the life-cycle and permanent income hypotheses, these increases should have no effect on individual spending decisions. In contrast, the relative income hypothesis predicts a substantial change in spending patterns in response to these changes. From statistical analysis of