Relative income concerns and the Easterlin Paradox: A theoretical framework

Year: 2023
Type: Journal Publication
Journal: Economic Modelling


This paper analyzes the relationship between relative income concerns and individual well-being in an economy of heterogeneous firm-worker pairs characterized by moral hazard with respect to the worker’s effort. At the individual level, we use the standard principal-agent paradigm to study the design of incentive contracts when workers compare their earnings with the economy’s average wage. At the aggregate level, we define the economy’s equilibrium and prove that it always exists. We then analyze the impact of technological improvements and identify various channels through which economy-wide income growth can negatively affect an individual’s well-being. We show that in many cases, an increase in average earnings generates the Easterlin Paradox, whereby average expected utility for workers is stagnant or even reduced. We discuss empirical predictions resulting from our model and suggest how our analysis can help evaluate the effects of various policy interventions.

Participating Institutions

TRR 266‘s main locations are Paderborn University (Coordinating University), HU Berlin, and University of Mannheim. All three locations have been centers for accounting and tax research for many years. They are joined by researchers from LMU Munich, Frankfurt School of Finance and Management, Goethe University Frankfurt, University of Cologne and Leibniz University Hannover who share the same research agenda.

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