No. 98: Keeping up with the Joneses and the Easterlin Paradox

Abstract

This paper analyses the relationship between relative income concerns and individual wellbeing in an economy of heterogeneous firm-worker pairs. Specifically, we study incentive contracting under moral hazard when workers compare their earnings with the economy’s average wage. At the aggregate level, we define the economy’s equilibrium and prove existence. We then analyse the impact of technological improvements and identify various channels through which an individual’s wellbeing can be negatively affected by economy-wide income growth, to the extent that, consistent with the Easterlin Paradox, an increase in average earnings can result in stagnant or even reduced average expected utility for workers.