Consumption externalities occur when consumption by some creates costs or benefits for others. According to Duesenberry’s ‘relative income hypothesis’, spending is influenced by the individual’s own standard of living in the recent past and the living standards of others in the present. This hypothesis tracks observed behaviour more closely than Friedman’s ‘permanent income hypothesis’, which assumes that context has no influence on spending. When context is more important for some goods (positional goods) than for others (non-positional goods), positional goods crowd out non-positional goods, causing welfare losses like those that occur when bombs crowd out consumption in military arms races.
KeywordsBequest motive Consumption externalities Friedman, M Hirsch, F Marx, K Permanent income hypothesis Positional goods Relative income hypothesis Revealed preference Savings Smith, A Veblen, T
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